Andy Xie
June 20, 2009
China’s lending boom since December 2008 has boosted bank loans by over Rmb 6 trillion. Many analysts think that an economic boom will follow in the second half of 2009. They will be disappointed. Much of the lending has not been invested and has flowed into asset markets. As money flows into speculation in asset markets, many believe that it will lead to spending boom through the wealth effect. First, creating a bubble to support the economy at best brings some short term benefits and more long term pain. Second, some of the speculation is actually hurting Chinese economy. The surge in commodity prices is fueled by China’s demand for speculative inventory. The damage is already significant. If lending doesn’t cool, this force would transfer Chinese income to foreigners and trigger stagflation for a long time to come.
Commodity prices have skyrocketed since March. The CRB index is up about one third. Several important commodities like oil and copper have doubled from the bottoms this year. As I have argued before, demand from financial buyers is driving commodity prices. The weak global economy can’t support high commodity prices. Instead, low interest rate and the fear of inflation are driving money into commodity buying. For example, exchange traded funds (‘ETFs’) alone account for half of the activities in oil future market. ETFs allow retail investors to behave like hedge funds. They could express their views efficiently. This product has serious implications for monetary policy making. One consequence is that the fear of inflation would lead to inflation through massive deployment of money into inflation-hedging assets like commodities.
Financial demand alone can’t support commodity prices. Financial buyers can’t take physical delivery and must sell the maturing futures contracts. This force would lead to steep price curve against time. In early 2009 the six month futures price for oil was twenty dollars higher than spot price. Unless spot price rises, financial buyers suffer huge losses. The wide gap between spot and futures price increased inventory demand as arbitrageurs sought to profit from the difference between warehousing cost and the price gap between spot and futures price. That demand flattened the price curve and diminished the losses to financial buyers. Without inventory demand financial speculation couldn’t work.
For some commodities the warehousing costs are low, i.e., the net loss for financial buyers is low. They can behave like pure financial products like stocks and bonds. Precious metals, for example, are like that. Copper, though five thousand times less valuable than gold, still has low warehousing cost relative to its value. Some commodities like lumber and iron ore are bulky, costly to warehouse, and should be less susceptible to financial speculation. Chinese players, however, are changing that. They can leverage China’s size to make everything possible for speculation.
There is little doubt by now that China’s bank lending since last December is driving speculative inventory demand for commodities. Chinese banks lend for commodity purchases with the underlying commodities as collaterals. The lending is structured similar to mortgage. Banks usually need to be much more cautious about such lending as commodity prices fluctuate far more than property prices. Chinese banks are more lenient. As China is an industrializing economy, it is understandable that the country should support industrial activities like purchasing raw materials for industrial production. However, when buying commodities is for speculation, the lenders suffer high risk without benefiting the economy. In some cases it hurts banks and the economy at the same time.
The speculative demand for iron ore, for example, is gravely hurting China’s national interest. Rio Tinto was suffering bankruptcy risk due to its overpriced and debt financed takeover of Alcan. When iron ore price dropped by two thirds from the peak, the market became worried about its viability and its share price became very low. Chinalco then negotiated a $19 billion investment in the company to support its finance. However, as its share price has nearly tripled from the bottom, it has decided to cancel the Chinalco investment and issue new shares instead. Chinalco essentially gave Rio Tinto a free call option. It ditched Chinalco when a better option became available. The issue is why its share price has done so well.
International media has been reporting record amounts of China’s commodity imports. The surge is being portrayed as reflecting China’s recovering economy. Indeed, international financial market is portraying China’s perceived recovery at the harbinger for global recovery. It is a major factor in pushing up stock prices around the world. But China’s imports are mostly for speculative inventories. Bank loans were so cheap and easy to get that many commodity distributors used the financing for speculation. The first wave of purchases was to arbitrage the difference between spot and futures prices. That was smart. As the price curves have flattened for most commodities, the imports are for speculating in price increase. As there are so many Chinese speculators, their demand is driving up prices, making the expectation self-fulfilling in the short term.
One obvious cost for China is the failure of Chinalco’s investment in Rio Tinto. When it saw its share price tripling, it could raise money cheaper by issuing new shares to pay down its debt. The potential financial loss to Chinalco isn’t the point. Bigger cost would come from further monopolization of iron ore market. After scrapping the Chinalco deal, Rio entered into an iron ore JV with BHP. Even though the two will keep separate marketing channels, joint production allows them to collude on production levels, which would have significant impact on future ore price.
The iron ore market has been brutal for China, partly due to China’s own inefficient system. For four decades before 2003 fine ore price fluctuated between $20-30/ton. As iron ore was plentiful in the world, its price was driven by production cost. After 2003 Chinese demand drove it out of the range. The contract price quadrupled to nearly $100/ton. The spot price reached nearly $200/ton in 2008. China imports more ore than Europe and Japan combined. The skyrocketing ore price has cost China dearly.
The gradual concentration of major iron ore mines among the big three was a major reason for the price increase. The nature of the Chinese demand was a major reason too. China’s steel production capacity has skyrocketed while the capacity is fragmented. Chinese local governments have been obsessed with promoting the growth of steel industry, which is the reason for the industry’s fragmentation. Huge demand and numerous small players are a perfect setup for the big three to increase prices. They often cite high spot prices as the reason for jagging up the contract prices. But, the spot market is relatively small. They can easily manipulate it by decreasing supply into the market. On the other hand, numerous Chinese steel mills all want to buy ore to sustain production for their governments to report higher GDP, even though the GDP is money losing. China’s steel industry is structured to hurt China’s interest.
As steel demand collapsed in the fourth quarter of 2008 and first quarter of 2009, steel prices fell sharply. It should be led to a collapse in ore demand. The surge in bank lending armed Chinese ore distributors with money to stock up ore for speculation. It has strengthened the hand of the big three enormously. The tie-up of BHP and Rio Tinto has increased their monopoly power further. Even though China is the biggest buyer of ore by far, it has had no power in price setting. When the global recession should have benefited China, the lending surge has made it even worse for China by financing Chinese speculative demand.
China is a resource scarce economy. The need for imports will only increase. International suppliers are trying to take advantage of the situation by consolidating. But Chinese buyers are fragmented due to local government protection. Chinese lending surge has made it worse by creating excessive speculative demand.
What is happening in the commodity market is a glaring example that China’s lending surge is hurting itself. Even more serious is that it is leading Chinese companies away from real business and further towards asset speculation. The tough economy and easy credit condition have led many companies trying to profit from asset appreciation. They have borrowed money and put it into stock market. As China’s stock market has risen by 70% since last November, many businesses feel vindicated for focusing on asset market rather than real business. The speculation has spread to Hong Kong. Mainland Chinese money may have been the force between HIS moving up to 19,000 from 15,000 and have been driving the luxury property sales. One way or another the money came from China’s lending binge.
Borrowing money for asset market speculation is not restricted to private companies. State owned enterprises appear to be lending money to private companies at high interest rate, i.e., loan sharking, with the cheap loans from the state-owned banks. Of course, we can’t estimate the magnitude of such SoE lending. What it has done is to replace the high interest rate financing in the gray market. As the economy weakened in late 2008 private lenders began demanding money back from distressed private companies. The lending from the state-owned enterprises may have kept many private companies from going bankrupt. It has served to re-channel the bank lending into cash for individuals and businesses that were in the lending business. This money may have flowed into asset markets. It is part of the phenomenon of the private sector withdrawing from the real economy into the virtual one.
The trend of businessmen becoming de facto fund managers or speculators is a worrisome one. It happened ten years ago in Hong Kong. Its economy has stagnated since. Some may argue that China has state-owned enterprises to lead the economy forward. However, even though state-owned enterprises account for more GDP, private companies account for most employment. The government is spending huge amounts of money to support temporary employment for the college graduates in 2009. If the employment in the private sector doesn’t grow, the government may have to spend even more next year. The government is using fiscal stimulus and bank lending to support economic recovery. But the recovery may be a jobless one. China needs a dynamic private sector to solve the employment problem.
We are seeing the dark side of the lending surge in supporting asset speculation. The commodity speculation is doing significant damage to the Chinese economy. More bank lending may lead to higher commodity prices, threatening stagflation for the Chinese economy. This self-inflected damage from China’s lending boom should be a major consideration in China’s lending policy. Cheap loans benefit foreigner commodity suppliers, not necessarily the Chinese economy.
Many analysts argue that GDP growth follows loan growth as money is spent. Inflation becomes a problem only when the economy overheats, which is still not a problem. This sort of thinking is naïve. We see the lent money is not spent in creating demand. It is being channeled into asset market speculation, which leads to inflation without boosting the economy. The long-term damage could be more serious as private businesses withdrawing from the real economy into the virtual one. When private companies don’t expand, China would suffer a lasting employment crisis. The lending surge may be hurting the Chinese economy both short term and long term.
The way that the bank lending has been channeled reflects that China’s economic problems couldn’t be fixed by liquidity. China’s growth model is based on government-led investment and foreign enterprise-led export. As exports grow, the government channels the income into investment to support export growth. As the global economy has collapsed, China’s exports have too. Unless the global economy comes back, China’s exports wouldn’t rise. There will be no income growth to support investment growth. The investment stimulus now is spending the saved income from past exports. It couldn’t last.
Unless China’s economic model changes, businesses really don’t want to invest. Without exports, who would be their customers? Hence, their response to put money into speculation isn’t totally irrational. It is better than expanding capacity, which would surely lead to losses.
If exports remain weak for years, China could only bring back high growth by shifting demand to household sector from export. It requires significant rebalancing of wealth and income in the Chinese economy. I have written repeatedly that a new growth cycle would start with distribution of the shares of the listed state-owned enterprises to Chinese households. It would lead to a virtuous cycle lasting a decade.
China’s bank lending surge has led to asset appreciation. Buoyant asset markets make many think that the economic problems are fixed. This may be an illusion. The lending surge may have created more problems than it solves. China’s economic problems are structural. They couldn’t be fixed by stimulus.
Tuesday, June 30, 2009
《人民日报》提醒中国银行业注意爆炸式放贷
Jason Leow
《人民日报》告诫中国银行业要注意向国家基础建设项目投入的巨额贷款的风险，对由各地方政府担保的数十亿美元债务的安全提出质疑。
今年以来，中国银行业按照政府的命令发放了大量贷款，以帮助旨在提振中国经济的公共建设工程筹措资金。但中国共产党中央委员会机关报《人民日报》周一发表评论文章说，银行不应该认定这些由地方政府担保的贷款是没有风险的。
《人民日报》近年来丧失了一定的权威性，不过仍能反映中国政府高层的想法。
中资银行向国有企业和地方政府敞开放贷，原因之一是它们预计贷款风险最终会由中央政府来承担。
《人民日报》称，今年前六个月，刺激性贷款很可能将超过人民币6万亿（合8,780亿美元），这是自1949年中华人民共和国成立以来新增贷款最多的一年。
该报表示，尽管长期来看刺激性贷款可能有一定的风险，一些放贷机构却任由这类贷款的放贷标准下降。
《人民日报》称，大部分贷款投向了铁路、高速公路和机场建设项目，这些项目最终将交予地方政府管理，地方政府而不是中央政府将保证贷款的偿还。
《人民日报》说，银行常常缺乏地方政府及其财务能力的准确、全面信息，令贷款风险增大。该报称，如果之后地方政府发现自己陷入财务困境，放贷机构的资产质量将受到影响。
《人民日报》称，短期来看，刺激性贷款似乎没有风险。但是长期来看，有些地方政府项目可能不会产生高回报，未来很长时间可能都无法偿还完贷款。一些项目可能难以产生足够的现金流，无力偿还本息。
这篇评论文章再次显示，官方担心刺激性贷款可能给经济造成长期问题。中国银行监管部门敦促商业银行加强对贷款人的审查，以确保贷款没有被滥用。
中国人民银行研究生部部务委员会副主席王自力说，中国银行业放贷规模引起了很多人的关注。银行需要认识到，人们现在把贷款风险视为一个社会问题而不是仅限于银行体系的问题。
The People's Daily newspaper has warned China's banks about the risks of loans they are pouring into state infrastructure projects, calling into question the safety of billions of dollars of debt backed by local governments country-wide.
China's banks have unleashed massive credit this year following a government order to help finance public-works construction aimed at pumping up the domestic economy. But banks shouldn't assume that such loans, backed by local governments, are risk-free, the Communist Party newspaper said in a commentary on Monday.
The People's Daily has lost some of its authority in recent years, but it can still reflect the thinking of China's top leaders.
Chinese banks have lent freely to state-owned enterprises and local governments, partly on expectations that the central government will ultimately underwrite the risk.
Stimulus lending in the first six months of the year is likely to exceed six trillion yuan ($878 billion), more new credit issued than in any year since the People's Republic of China was founded in 1949, the paper said.
Some lenders have let credit standards slip for stimulus loans even though such loans could bear some risks in the long term, the paper said.
Most of the lending goes to railroad, highway and airport building projects that eventually are handed over to local governments to manage, and it is the local authorities -- not central government -- that will guarantee loan repayments, it said.
Banks often lack accurate and full information about local governments and their financial viability, increasing their credit risks, it said. Lenders' asset quality will suffer if local governments later find themselves in financial trouble, it said.
'In the short run, it appears that [stimulus lending] is risk-free. But in the long term, there are some local government projects that may not yield high returns and the payback could be due long into the future. Such projects may not generate enough cash flow for either the principal or interest payments,' the paper said.
The commentary marks the latest sign of official concern that stimulus lending could be creating long-term problems for the economy. China's bank regulator has urged commercial banks to scrutinize borrowers more closely to ensure that loans aren't misused.
'China's bank lending numbers have caught the attention of many people. Banks need to realize people now regard lending risks as a social problem rather than one confined to the banking system,' said Wang Zili, a vice-chairman of the graduate school of the central bank.
《人民日报》告诫中国银行业要注意向国家基础建设项目投入的巨额贷款的风险，对由各地方政府担保的数十亿美元债务的安全提出质疑。
今年以来，中国银行业按照政府的命令发放了大量贷款，以帮助旨在提振中国经济的公共建设工程筹措资金。但中国共产党中央委员会机关报《人民日报》周一发表评论文章说，银行不应该认定这些由地方政府担保的贷款是没有风险的。
《人民日报》近年来丧失了一定的权威性，不过仍能反映中国政府高层的想法。
中资银行向国有企业和地方政府敞开放贷，原因之一是它们预计贷款风险最终会由中央政府来承担。
《人民日报》称，今年前六个月，刺激性贷款很可能将超过人民币6万亿（合8,780亿美元），这是自1949年中华人民共和国成立以来新增贷款最多的一年。
该报表示，尽管长期来看刺激性贷款可能有一定的风险，一些放贷机构却任由这类贷款的放贷标准下降。
《人民日报》称，大部分贷款投向了铁路、高速公路和机场建设项目，这些项目最终将交予地方政府管理，地方政府而不是中央政府将保证贷款的偿还。
《人民日报》说，银行常常缺乏地方政府及其财务能力的准确、全面信息，令贷款风险增大。该报称，如果之后地方政府发现自己陷入财务困境，放贷机构的资产质量将受到影响。
《人民日报》称，短期来看，刺激性贷款似乎没有风险。但是长期来看，有些地方政府项目可能不会产生高回报，未来很长时间可能都无法偿还完贷款。一些项目可能难以产生足够的现金流，无力偿还本息。
这篇评论文章再次显示，官方担心刺激性贷款可能给经济造成长期问题。中国银行监管部门敦促商业银行加强对贷款人的审查，以确保贷款没有被滥用。
中国人民银行研究生部部务委员会副主席王自力说，中国银行业放贷规模引起了很多人的关注。银行需要认识到，人们现在把贷款风险视为一个社会问题而不是仅限于银行体系的问题。
The People's Daily newspaper has warned China's banks about the risks of loans they are pouring into state infrastructure projects, calling into question the safety of billions of dollars of debt backed by local governments country-wide.
China's banks have unleashed massive credit this year following a government order to help finance public-works construction aimed at pumping up the domestic economy. But banks shouldn't assume that such loans, backed by local governments, are risk-free, the Communist Party newspaper said in a commentary on Monday.
The People's Daily has lost some of its authority in recent years, but it can still reflect the thinking of China's top leaders.
Chinese banks have lent freely to state-owned enterprises and local governments, partly on expectations that the central government will ultimately underwrite the risk.
Stimulus lending in the first six months of the year is likely to exceed six trillion yuan ($878 billion), more new credit issued than in any year since the People's Republic of China was founded in 1949, the paper said.
Some lenders have let credit standards slip for stimulus loans even though such loans could bear some risks in the long term, the paper said.
Most of the lending goes to railroad, highway and airport building projects that eventually are handed over to local governments to manage, and it is the local authorities -- not central government -- that will guarantee loan repayments, it said.
Banks often lack accurate and full information about local governments and their financial viability, increasing their credit risks, it said. Lenders' asset quality will suffer if local governments later find themselves in financial trouble, it said.
'In the short run, it appears that [stimulus lending] is risk-free. But in the long term, there are some local government projects that may not yield high returns and the payback could be due long into the future. Such projects may not generate enough cash flow for either the principal or interest payments,' the paper said.
The commentary marks the latest sign of official concern that stimulus lending could be creating long-term problems for the economy. China's bank regulator has urged commercial banks to scrutinize borrowers more closely to ensure that loans aren't misused.
'China's bank lending numbers have caught the attention of many people. Banks need to realize people now regard lending risks as a social problem rather than one confined to the banking system,' said Wang Zili, a vice-chairman of the graduate school of the central bank.
Northeast U.S., So Far Spared, Could Still Face Home Price Pain
WSJ
For many U.S. homeowners, crisis hasn't meant urgency. Just as potential buyers have waited, many would-be sellers facing paper losses have not been forced to act. The standoff shouldn't be confused with stability.
The housing freefall slowed in April. Prices dropped 18.1% year on year, according to S&P/Case-Shiller's index of 20 cities. They were lower in every city, but economists were encouraged by slightly more modest declines compared with March -- a possible sign the market is near a bottom.
In some overbuilt cities, foreclosures have helped clear inventory while rapidly bringing prices back to reality. Phoenix and Las Vegas, for instance, have seen prices fall back nearly to 2000 levels.
But markets like Boston and New York, where prices rose during the boom, albeit not as drastically as the Sun Belt, have slid much slower. Prices in Boston are still 48% above 2000 levels and New York's prices are 71% higher. Valuations in both cities are only about 20% off their peaks.
Would-be sellers in the Northeast appear to be taking their time. There, the inventory of homes for sale has increased just 17% since the end of 2005, before the market bubble burst, according to the Census Bureau. In the West, meanwhile, inventories have risen 74% over the same time period.
Transaction volumes tell a similar story. The National Association of Realtors says existing home sales in the Northeast fell 10% year on year in April, while they increased 17% in the West.
Home prices in the less overbuilt Northeast are unlikely to correct as sharply as in some other markets. But further pain has likely been delayed, not avoided.
For many U.S. homeowners, crisis hasn't meant urgency. Just as potential buyers have waited, many would-be sellers facing paper losses have not been forced to act. The standoff shouldn't be confused with stability.
The housing freefall slowed in April. Prices dropped 18.1% year on year, according to S&P/Case-Shiller's index of 20 cities. They were lower in every city, but economists were encouraged by slightly more modest declines compared with March -- a possible sign the market is near a bottom.
In some overbuilt cities, foreclosures have helped clear inventory while rapidly bringing prices back to reality. Phoenix and Las Vegas, for instance, have seen prices fall back nearly to 2000 levels.
But markets like Boston and New York, where prices rose during the boom, albeit not as drastically as the Sun Belt, have slid much slower. Prices in Boston are still 48% above 2000 levels and New York's prices are 71% higher. Valuations in both cities are only about 20% off their peaks.
Would-be sellers in the Northeast appear to be taking their time. There, the inventory of homes for sale has increased just 17% since the end of 2005, before the market bubble burst, according to the Census Bureau. In the West, meanwhile, inventories have risen 74% over the same time period.
Transaction volumes tell a similar story. The National Association of Realtors says existing home sales in the Northeast fell 10% year on year in April, while they increased 17% in the West.
Home prices in the less overbuilt Northeast are unlikely to correct as sharply as in some other markets. But further pain has likely been delayed, not avoided.
How every new bull market has its own special shape
By Michael Gordon
Published: June 30 2009 03:00 Last updated: June 30 2009 03:00
Since the lows of March of this year, the steady rise in equity markets and the contraction in credit spreads have brought cheer.
The reasons for the bounce in listed asset prices since March lie in a combination of a deceleration in the fall of levels of economic activity and the availability of some very oversold price levels that had been caused by deleveraging.
The end of that vicious downward cycle was always likely to be the catalyst for a decent rally, if not a new bull market.
But a new bull market is almost always different from the last. Market leadership changes. This point has been absent from the rise in prices in recent months.
The required change in market leadership is generally seen through geographic, sector, industry and size rotation.
For example, the bull market of the second half of the 1990s was led by technology in the US. Such was the force of this leadership that the US market was able to rise in 1999 in spite of more stocks falling than rising during that year. That market died when the dotcom bubble burst in 2000.
The bull market that arose from the ashes of the 2000-2002 bear market found leadership in Asia and the emerging economies, from a geographic perspective, and, commensurate with that, in the natural resources industries. Financials played their part, as they were able to feed off the bull market and lower interest rates, providing the leverage that was ultimately to engineer last year's collapse. Technology stocks were laggards.
However, as pretty much every area of the markets registered gains, diversification seemed to lessen in importance and was harder to obtain for many portfolio investors.
Moreover, as leveraged money found its way to the new destinations, diversification became "leversification" as leveraged investors chased the same assets and their performance became more homogeneous.
Globalisation has many benefits, but the portability of investments through the opening of markets and lifting of exchange and ownership controls over the past 20 years meant money followed money, with freedom, focus and a velocity that had few precedents.
Now, as confidence returns, we see the same thing, with the same leaders and laggards. It is the dollar or not. It is government bonds or equities and commodities - which have almost become fungible from an asset allocation perspective. The dollar and treasuries are funding non-dollar real asset markets, significantly in the emerging world. It is 2006 all over again, in the listed world.
"ABD" is the cry - "anything but dollars". Money flows seem one way again, and if sentiment were to tick down, we would probably see the dollar and G7 government bonds do well.
Everything else would fall. Such binary outcomes are not what diversified investors such as pension fund trustees need or desire. It is not a healthy situation. What is to be done?
First, portfolio investors must realise that the nature and characteristics of the marginal investor are vital. From 2003 to 2007, many balanced fund investors and pension fund trustees took comfort in the fact that their portfolios were apparently diversified, across asset class, geography and industry. While giving the appearance of diversity based on long-term historical price series and their standard deviations, the reality was different. The marginal investors' rationale, time-frame and levels of leverage were key and remain so.
Second, for those who seek diversification, the rule suggesting a spread of assets might no longer be relevant. The type of stress testing in place in banks could be equally appropriate for pension funds.
Liquidity is also critical. As we saw during the crisis, many supposedly liquid markets seized up.
The current market feels too much like the most recently deceased bull market for comfort. That has implications for price levels and correlations. Those concerned by risk matters need to be wary on both counts.
The writer is a former chief investment officer at Fidelity International
Published: June 30 2009 03:00 Last updated: June 30 2009 03:00
Since the lows of March of this year, the steady rise in equity markets and the contraction in credit spreads have brought cheer.
The reasons for the bounce in listed asset prices since March lie in a combination of a deceleration in the fall of levels of economic activity and the availability of some very oversold price levels that had been caused by deleveraging.
The end of that vicious downward cycle was always likely to be the catalyst for a decent rally, if not a new bull market.
But a new bull market is almost always different from the last. Market leadership changes. This point has been absent from the rise in prices in recent months.
The required change in market leadership is generally seen through geographic, sector, industry and size rotation.
For example, the bull market of the second half of the 1990s was led by technology in the US. Such was the force of this leadership that the US market was able to rise in 1999 in spite of more stocks falling than rising during that year. That market died when the dotcom bubble burst in 2000.
The bull market that arose from the ashes of the 2000-2002 bear market found leadership in Asia and the emerging economies, from a geographic perspective, and, commensurate with that, in the natural resources industries. Financials played their part, as they were able to feed off the bull market and lower interest rates, providing the leverage that was ultimately to engineer last year's collapse. Technology stocks were laggards.
However, as pretty much every area of the markets registered gains, diversification seemed to lessen in importance and was harder to obtain for many portfolio investors.
Moreover, as leveraged money found its way to the new destinations, diversification became "leversification" as leveraged investors chased the same assets and their performance became more homogeneous.
Globalisation has many benefits, but the portability of investments through the opening of markets and lifting of exchange and ownership controls over the past 20 years meant money followed money, with freedom, focus and a velocity that had few precedents.
Now, as confidence returns, we see the same thing, with the same leaders and laggards. It is the dollar or not. It is government bonds or equities and commodities - which have almost become fungible from an asset allocation perspective. The dollar and treasuries are funding non-dollar real asset markets, significantly in the emerging world. It is 2006 all over again, in the listed world.
"ABD" is the cry - "anything but dollars". Money flows seem one way again, and if sentiment were to tick down, we would probably see the dollar and G7 government bonds do well.
Everything else would fall. Such binary outcomes are not what diversified investors such as pension fund trustees need or desire. It is not a healthy situation. What is to be done?
First, portfolio investors must realise that the nature and characteristics of the marginal investor are vital. From 2003 to 2007, many balanced fund investors and pension fund trustees took comfort in the fact that their portfolios were apparently diversified, across asset class, geography and industry. While giving the appearance of diversity based on long-term historical price series and their standard deviations, the reality was different. The marginal investors' rationale, time-frame and levels of leverage were key and remain so.
Second, for those who seek diversification, the rule suggesting a spread of assets might no longer be relevant. The type of stress testing in place in banks could be equally appropriate for pension funds.
Liquidity is also critical. As we saw during the crisis, many supposedly liquid markets seized up.
The current market feels too much like the most recently deceased bull market for comfort. That has implications for price levels and correlations. Those concerned by risk matters need to be wary on both counts.
The writer is a former chief investment officer at Fidelity International
Monday, June 29, 2009
Study Questions Cancer Drugs' Cost Effectiveness
By AVERY JOHNSON
The widespread use of expensive cancer drugs to prolong patients' lives by just weeks or months was called into question by an article published Monday in the Journal of the National Cancer Institute.
Crunching data from published studies, the authors found that treating a lung-cancer patient with Erbitux, a drug that costs $80,000 for an 18-week regimen, only prolongs survival by 1.2 months. Based on that estimate, extending the lives of the 550,000 Americans who die of cancer annually by one year would cost $440 billion, they extrapolated.
How to control escalating spending on end-of-life care is one of the thorniest questions facing lawmakers working on the overhaul of the U.S. health-care system. Some countries, like the United Kingdom, agree to pay for expensive drugs only if they meet a certain threshold of efficacy, but no such rationing exists in the U.S.
In addition to Erbitux, which is co-marketed by Eli Lilly & Co. and Bristol-Myers Squibb Co., the authors questioned the cost-benefit calculus for other big sellers such as Roche Holding AG's Avastin and Nexavar, which is co-marketed by Bayer AG and Onyx Pharmaceuticals, citing similarly limited survival data. The latter two drugs cost more than $34,000 for a standard course of treatment.
The authors, Tito Fojo, an oncologist with the National Cancer Institute, and Christine Grady, a bioethicist at the National Institutes of Health, called for changes in the testing and practice of medicine, noting that more than 90% of cancer medicines approved in the last four years in the U.S. cost more than $20,000 for a 12-week course.
Drug makers said the article exaggerated the overall costs of their treatments because few patients are on them for extended periods of time. They added that many patients qualify for financial assistance and that the high list prices of the drugs reflect the high cost of scientific innovation.
Brian Henry, a spokesman for Bristol-Myers, says that the real-world price that patients pay for Erbitux is closer to $10,000 a month; the $80,000 figure that the article uses reflects a benchmark price known as average wholesale price that isn't typically paid by anyone. "The total cost of Erbitux therapy varies depending on the course of treatment for an individual patient. The course of treatment is determined by the type of cancer, stage of disease, line of therapy, dosing schedule and duration of treatment based on clinical data," says Mr. Henry, who adds that Erbitux isn't approved to treat lung cancer.
Nonetheless, the authors called for not testing drugs with marginal benefits unless they can be sold for under $20,000. They also urged oncologists to cease the widespread practice of prescribing medicines outside of their officially approved indications and to avoid trying new drugs with limited upside on patients with advanced cancer.
"Many Americans would not regard a 1.2-month survival advantage as 'significant' progress," the authors wrote. "But would an individual patient disagree? Although we lack the answer to that question, we would suggest that the death of a mother of four at age 37 years would be no less painful were it to occur at age 37 years and 1 month."
While some policy experts consider the rationing of health care resources inevitable in the quest to control medical spending, many Americans have long resisted putting the collective fiscal good over their individual health.
The debate is complicated by the fact that, in some cases, the drugs work very well. "A drug like Erbitux is not very impressive when you look at the statistics, but for some it's just remarkable," says Robert Erwin, who heads the cancer advocacy group Marti Nelson Cancer Foundation. "How much does it cost for the person to have the opportunity to benefit, whether they get the benefit or not?"
Richard Heimler, 49, is among the patients who has benefited from high-cost treatments. He was diagnosed with lung cancer five years ago. In January, he added Avastin to a regimen of other expensive drugs. He credits it with shrinking his tumors within two months of starting treatment.
"My strategy has been to stay alive until the next drug comes out, and then stay alive long enough for the next drug after that," says Mr. Heimler, who lives in New York and was head of development for a nonprofit before retiring two years ago. "If my family and I can afford a drug, we'll try it. It's hard to put a value on a life."
But for Roger Megerth, 73, prolonged treatment with Nexavar wasn't worth it. He started taking Nexavar last June after being diagnosed with kidney cancer, but the side effects -- indigestion, bleeding in the mouth and intestinal problems -- were mounting.
So were the bills. The retired teacher says his school district switched prescription-drug plans and his co-pay for a bottle of 30 pills jumped from $20 to $988.18. He put one month's supply on his credit card and decided to forgo further treatment after that.
"I would've borrowed money and run out my visa," but the side effects weren't worth it, says Mr. Megerth of Billings, Mont. He says his disease is under control for now, but he's in considerable pain and needs a walker to move around comfortably.
A spokeswoman for Onyx says that 75% of patients on Nexavar spend $50 or less out of pocket for the drug and that patient assistance programs are available to cover the remainder of its costs.
Write to Avery Johnson at avery.johnson@WSJ.com
The widespread use of expensive cancer drugs to prolong patients' lives by just weeks or months was called into question by an article published Monday in the Journal of the National Cancer Institute.
Crunching data from published studies, the authors found that treating a lung-cancer patient with Erbitux, a drug that costs $80,000 for an 18-week regimen, only prolongs survival by 1.2 months. Based on that estimate, extending the lives of the 550,000 Americans who die of cancer annually by one year would cost $440 billion, they extrapolated.
How to control escalating spending on end-of-life care is one of the thorniest questions facing lawmakers working on the overhaul of the U.S. health-care system. Some countries, like the United Kingdom, agree to pay for expensive drugs only if they meet a certain threshold of efficacy, but no such rationing exists in the U.S.
In addition to Erbitux, which is co-marketed by Eli Lilly & Co. and Bristol-Myers Squibb Co., the authors questioned the cost-benefit calculus for other big sellers such as Roche Holding AG's Avastin and Nexavar, which is co-marketed by Bayer AG and Onyx Pharmaceuticals, citing similarly limited survival data. The latter two drugs cost more than $34,000 for a standard course of treatment.
The authors, Tito Fojo, an oncologist with the National Cancer Institute, and Christine Grady, a bioethicist at the National Institutes of Health, called for changes in the testing and practice of medicine, noting that more than 90% of cancer medicines approved in the last four years in the U.S. cost more than $20,000 for a 12-week course.
Drug makers said the article exaggerated the overall costs of their treatments because few patients are on them for extended periods of time. They added that many patients qualify for financial assistance and that the high list prices of the drugs reflect the high cost of scientific innovation.
Brian Henry, a spokesman for Bristol-Myers, says that the real-world price that patients pay for Erbitux is closer to $10,000 a month; the $80,000 figure that the article uses reflects a benchmark price known as average wholesale price that isn't typically paid by anyone. "The total cost of Erbitux therapy varies depending on the course of treatment for an individual patient. The course of treatment is determined by the type of cancer, stage of disease, line of therapy, dosing schedule and duration of treatment based on clinical data," says Mr. Henry, who adds that Erbitux isn't approved to treat lung cancer.
Nonetheless, the authors called for not testing drugs with marginal benefits unless they can be sold for under $20,000. They also urged oncologists to cease the widespread practice of prescribing medicines outside of their officially approved indications and to avoid trying new drugs with limited upside on patients with advanced cancer.
"Many Americans would not regard a 1.2-month survival advantage as 'significant' progress," the authors wrote. "But would an individual patient disagree? Although we lack the answer to that question, we would suggest that the death of a mother of four at age 37 years would be no less painful were it to occur at age 37 years and 1 month."
While some policy experts consider the rationing of health care resources inevitable in the quest to control medical spending, many Americans have long resisted putting the collective fiscal good over their individual health.
The debate is complicated by the fact that, in some cases, the drugs work very well. "A drug like Erbitux is not very impressive when you look at the statistics, but for some it's just remarkable," says Robert Erwin, who heads the cancer advocacy group Marti Nelson Cancer Foundation. "How much does it cost for the person to have the opportunity to benefit, whether they get the benefit or not?"
Richard Heimler, 49, is among the patients who has benefited from high-cost treatments. He was diagnosed with lung cancer five years ago. In January, he added Avastin to a regimen of other expensive drugs. He credits it with shrinking his tumors within two months of starting treatment.
"My strategy has been to stay alive until the next drug comes out, and then stay alive long enough for the next drug after that," says Mr. Heimler, who lives in New York and was head of development for a nonprofit before retiring two years ago. "If my family and I can afford a drug, we'll try it. It's hard to put a value on a life."
But for Roger Megerth, 73, prolonged treatment with Nexavar wasn't worth it. He started taking Nexavar last June after being diagnosed with kidney cancer, but the side effects -- indigestion, bleeding in the mouth and intestinal problems -- were mounting.
So were the bills. The retired teacher says his school district switched prescription-drug plans and his co-pay for a bottle of 30 pills jumped from $20 to $988.18. He put one month's supply on his credit card and decided to forgo further treatment after that.
"I would've borrowed money and run out my visa," but the side effects weren't worth it, says Mr. Megerth of Billings, Mont. He says his disease is under control for now, but he's in considerable pain and needs a walker to move around comfortably.
A spokeswoman for Onyx says that 75% of patients on Nexavar spend $50 or less out of pocket for the drug and that patient assistance programs are available to cover the remainder of its costs.
Write to Avery Johnson at avery.johnson@WSJ.com
Betraying the Planet
Paul Krugman
So the House passed the Waxman-Markey climate-change bill. In political terms, it was a remarkable achievement.
But 212 representatives voted no. A handful of these no votes came from representatives who considered the bill too weak, but most rejected the bill because they rejected the whole notion that we have to do something about greenhouse gases.
And as I watched the deniers make their arguments, I couldn’t help thinking that I was watching a form of treason — treason against the planet.
To fully appreciate the irresponsibility and immorality of climate-change denial, you need to know about the grim turn taken by the latest climate research.
The fact is that the planet is changing faster than even pessimists expected: ice caps are shrinking, arid zones spreading, at a terrifying rate. And according to a number of recent studies, catastrophe — a rise in temperature so large as to be almost unthinkable — can no longer be considered a mere possibility. It is, instead, the most likely outcome if we continue along our present course.
Thus researchers at M.I.T., who were previously predicting a temperature rise of a little more than 4 degrees by the end of this century, are now predicting a rise of more than 9 degrees. Why? Global greenhouse gas emissions are rising faster than expected; some mitigating factors, like absorption of carbon dioxide by the oceans, are turning out to be weaker than hoped; and there’s growing evidence that climate change is self-reinforcing — that, for example, rising temperatures will cause some arctic tundra to defrost, releasing even more carbon dioxide into the atmosphere.
Temperature increases on the scale predicted by the M.I.T. researchers and others would create huge disruptions in our lives and our economy. As a recent authoritative U.S. government report points out, by the end of this century New Hampshire may well have the climate of North Carolina today, Illinois may have the climate of East Texas, and across the country extreme, deadly heat waves — the kind that traditionally occur only once in a generation — may become annual or biannual events.
In other words, we’re facing a clear and present danger to our way of life, perhaps even to civilization itself. How can anyone justify failing to act?
Well, sometimes even the most authoritative analyses get things wrong. And if dissenting opinion-makers and politicians based their dissent on hard work and hard thinking — if they had carefully studied the issue, consulted with experts and concluded that the overwhelming scientific consensus was misguided — they could at least claim to be acting responsibly.
But if you watched the debate on Friday, you didn’t see people who’ve thought hard about a crucial issue, and are trying to do the right thing. What you saw, instead, were people who show no sign of being interested in the truth. They don’t like the political and policy implications of climate change, so they’ve decided not to believe in it — and they’ll grab any argument, no matter how disreputable, that feeds their denial.
Indeed, if there was a defining moment in Friday’s debate, it was the declaration by Representative Paul Broun of Georgia that climate change is nothing but a “hoax” that has been “perpetrated out of the scientific community.” I’d call this a crazy conspiracy theory, but doing so would actually be unfair to crazy conspiracy theorists. After all, to believe that global warming is a hoax you have to believe in a vast cabal consisting of thousands of scientists — a cabal so powerful that it has managed to create false records on everything from global temperatures to Arctic sea ice.
Yet Mr. Broun’s declaration was met with applause.
Given this contempt for hard science, I’m almost reluctant to mention the deniers’ dishonesty on matters economic. But in addition to rejecting climate science, the opponents of the climate bill made a point of misrepresenting the results of studies of the bill’s economic impact, which all suggest that the cost will be relatively low.
Still, is it fair to call climate denial a form of treason? Isn’t it politics as usual?
Yes, it is — and that’s why it’s unforgivable.
Do you remember the days when Bush administration officials claimed that terrorism posed an “existential threat” to America, a threat in whose face normal rules no longer applied? That was hyperbole — but the existential threat from climate change is all too real.
Yet the deniers are choosing, willfully, to ignore that threat, placing future generations of Americans in grave danger, simply because it’s in their political interest to pretend that there’s nothing to worry about. If that’s not betrayal, I don’t know what is.
So the House passed the Waxman-Markey climate-change bill. In political terms, it was a remarkable achievement.
But 212 representatives voted no. A handful of these no votes came from representatives who considered the bill too weak, but most rejected the bill because they rejected the whole notion that we have to do something about greenhouse gases.
And as I watched the deniers make their arguments, I couldn’t help thinking that I was watching a form of treason — treason against the planet.
To fully appreciate the irresponsibility and immorality of climate-change denial, you need to know about the grim turn taken by the latest climate research.
The fact is that the planet is changing faster than even pessimists expected: ice caps are shrinking, arid zones spreading, at a terrifying rate. And according to a number of recent studies, catastrophe — a rise in temperature so large as to be almost unthinkable — can no longer be considered a mere possibility. It is, instead, the most likely outcome if we continue along our present course.
Thus researchers at M.I.T., who were previously predicting a temperature rise of a little more than 4 degrees by the end of this century, are now predicting a rise of more than 9 degrees. Why? Global greenhouse gas emissions are rising faster than expected; some mitigating factors, like absorption of carbon dioxide by the oceans, are turning out to be weaker than hoped; and there’s growing evidence that climate change is self-reinforcing — that, for example, rising temperatures will cause some arctic tundra to defrost, releasing even more carbon dioxide into the atmosphere.
Temperature increases on the scale predicted by the M.I.T. researchers and others would create huge disruptions in our lives and our economy. As a recent authoritative U.S. government report points out, by the end of this century New Hampshire may well have the climate of North Carolina today, Illinois may have the climate of East Texas, and across the country extreme, deadly heat waves — the kind that traditionally occur only once in a generation — may become annual or biannual events.
In other words, we’re facing a clear and present danger to our way of life, perhaps even to civilization itself. How can anyone justify failing to act?
Well, sometimes even the most authoritative analyses get things wrong. And if dissenting opinion-makers and politicians based their dissent on hard work and hard thinking — if they had carefully studied the issue, consulted with experts and concluded that the overwhelming scientific consensus was misguided — they could at least claim to be acting responsibly.
But if you watched the debate on Friday, you didn’t see people who’ve thought hard about a crucial issue, and are trying to do the right thing. What you saw, instead, were people who show no sign of being interested in the truth. They don’t like the political and policy implications of climate change, so they’ve decided not to believe in it — and they’ll grab any argument, no matter how disreputable, that feeds their denial.
Indeed, if there was a defining moment in Friday’s debate, it was the declaration by Representative Paul Broun of Georgia that climate change is nothing but a “hoax” that has been “perpetrated out of the scientific community.” I’d call this a crazy conspiracy theory, but doing so would actually be unfair to crazy conspiracy theorists. After all, to believe that global warming is a hoax you have to believe in a vast cabal consisting of thousands of scientists — a cabal so powerful that it has managed to create false records on everything from global temperatures to Arctic sea ice.
Yet Mr. Broun’s declaration was met with applause.
Given this contempt for hard science, I’m almost reluctant to mention the deniers’ dishonesty on matters economic. But in addition to rejecting climate science, the opponents of the climate bill made a point of misrepresenting the results of studies of the bill’s economic impact, which all suggest that the cost will be relatively low.
Still, is it fair to call climate denial a form of treason? Isn’t it politics as usual?
Yes, it is — and that’s why it’s unforgivable.
Do you remember the days when Bush administration officials claimed that terrorism posed an “existential threat” to America, a threat in whose face normal rules no longer applied? That was hyperbole — but the existential threat from climate change is all too real.
Yet the deniers are choosing, willfully, to ignore that threat, placing future generations of Americans in grave danger, simply because it’s in their political interest to pretend that there’s nothing to worry about. If that’s not betrayal, I don’t know what is.
Banks' Bugbear: Commercial Real Estate
By PETER EAVIS
A reason to love banks as investments also can be a reason to hate them. Because of the way they account for most loans, banks can absorb credit losses over time, allowing them to earn their way out of trouble. A potential downside of this approach: Banks use it to postpone the recognition of losses. And commercial real-estate lending is one area where losses are likely to be enormous.
As a result, investors need to look out for potential danger signs flashing over bank exposure to commercial real estate. First steps include measuring commercial real estate as a percentage of tangible common equity and spotting large exposures to once-overheated markets. These might have already raised red flags about a bank like Synovus Financial, whose commercial real-estate exposures are a reason its stock hasn't participated in the bank-stock bounce since March.
Of course, problems are rarely obvious. And the longer commercial real estate remains depressed, the greater the need to burrow into banks for signs that commercial real-estate losses could end up being larger than expected.
First, look out for banks that have taken almost no hits to commercial real estate, especially if they are in stressed markets. Take City National, a Los Angeles bank with $17 billion in assets. Granted, its construction loans are showing considerable weakness. But the commercial real-estate book for finished buildings looks pristine. Since the start of 2007 that $2.17 billion portfolio has shown net charge-offs of only $838,000. And nonperforming loans of $16.9 million amount to a mere 0.8% of the total.
In effect, that means that commercial real-estate book is held at about 99 cents on the dollar. Of course, City National may get through the storm with low losses. But the fact that it has taken such a small hit could mean that there is more pain ahead.
The stock, trading at 1.4 times tangible book, could be vulnerable.
Another tack is to try to get a closer read on the actual properties backing commercial real-estate loans, to see what banks might make back in the event of foreclosure. CVB Financial, a bank-holding company in Ontario, Calif., has high exposure to commercial real estate in the Inland Empire, one of the worst-hit markets in the U.S.
One local borrower is a property-investment firm called the Garrett Group.
It has borrowed about $85 million from CVB Financial's bank subsidiary, according to Garrett Chief Executive Kirk Wright. That is about 19% of CVB's tangible equity.
Court documents give details of some of the commercial real-estate collateral Garrett has provided, and in some cases it is land, which in the Inland Empire can be worth little.
Mr. Wright said the collateral is worth more than 100% of the loan. But he also said: "We have got such a fluid market. It could be 120%, 150% or 90%." He said the collateral also includes interests in limited liability corporations, but he declined to give more details. CVB Financial trades at a healthy 1.2 times tangible book.
Commercial real estate can even be an issue for investors after underlying properties have been foreclosed on. Then, investors should gauge if banks are holding onto foreclosed assets for too long, exposing them to falling recovery values.
BB&T's foreclosed assets, mostly real estate, totaled just over $1 billion in the first quarter, equivalent to 37% of nonperforming assets. That is more than double the 14% average for Regions Financial, SunTrust Banks and Synovus. And BB&T said the first-quarter increase in foreclosed assets was mainly due to soured commercial real-estate projects.
As the commercial real-estate crackup continues, investors looking for value among America's regional banks need their wits about them.
Write to Peter Eavis at peter.eavis@wsj.com
A reason to love banks as investments also can be a reason to hate them. Because of the way they account for most loans, banks can absorb credit losses over time, allowing them to earn their way out of trouble. A potential downside of this approach: Banks use it to postpone the recognition of losses. And commercial real-estate lending is one area where losses are likely to be enormous.
As a result, investors need to look out for potential danger signs flashing over bank exposure to commercial real estate. First steps include measuring commercial real estate as a percentage of tangible common equity and spotting large exposures to once-overheated markets. These might have already raised red flags about a bank like Synovus Financial, whose commercial real-estate exposures are a reason its stock hasn't participated in the bank-stock bounce since March.
Of course, problems are rarely obvious. And the longer commercial real estate remains depressed, the greater the need to burrow into banks for signs that commercial real-estate losses could end up being larger than expected.
First, look out for banks that have taken almost no hits to commercial real estate, especially if they are in stressed markets. Take City National, a Los Angeles bank with $17 billion in assets. Granted, its construction loans are showing considerable weakness. But the commercial real-estate book for finished buildings looks pristine. Since the start of 2007 that $2.17 billion portfolio has shown net charge-offs of only $838,000. And nonperforming loans of $16.9 million amount to a mere 0.8% of the total.
In effect, that means that commercial real-estate book is held at about 99 cents on the dollar. Of course, City National may get through the storm with low losses. But the fact that it has taken such a small hit could mean that there is more pain ahead.
The stock, trading at 1.4 times tangible book, could be vulnerable.
Another tack is to try to get a closer read on the actual properties backing commercial real-estate loans, to see what banks might make back in the event of foreclosure. CVB Financial, a bank-holding company in Ontario, Calif., has high exposure to commercial real estate in the Inland Empire, one of the worst-hit markets in the U.S.
One local borrower is a property-investment firm called the Garrett Group.
It has borrowed about $85 million from CVB Financial's bank subsidiary, according to Garrett Chief Executive Kirk Wright. That is about 19% of CVB's tangible equity.
Court documents give details of some of the commercial real-estate collateral Garrett has provided, and in some cases it is land, which in the Inland Empire can be worth little.
Mr. Wright said the collateral is worth more than 100% of the loan. But he also said: "We have got such a fluid market. It could be 120%, 150% or 90%." He said the collateral also includes interests in limited liability corporations, but he declined to give more details. CVB Financial trades at a healthy 1.2 times tangible book.
Commercial real estate can even be an issue for investors after underlying properties have been foreclosed on. Then, investors should gauge if banks are holding onto foreclosed assets for too long, exposing them to falling recovery values.
BB&T's foreclosed assets, mostly real estate, totaled just over $1 billion in the first quarter, equivalent to 37% of nonperforming assets. That is more than double the 14% average for Regions Financial, SunTrust Banks and Synovus. And BB&T said the first-quarter increase in foreclosed assets was mainly due to soured commercial real-estate projects.
As the commercial real-estate crackup continues, investors looking for value among America's regional banks need their wits about them.
Write to Peter Eavis at peter.eavis@wsj.com
Boeing Feels New Pressure to Placate Its 787 Buyers
By PETER SANDERS and DANIEL MICHAELS
The latest delay to hit Boeing Co.'s 787 Dreamliner has complicated an intricate set of negotiations, giving airlines a chance to wrangle concessions from the plane maker on delivery dates, installment payments and even the final purchase price.
Already nearly two years behind schedule, the Dreamliner was the fastest selling commercial airplane in Boeing history -- at one point over 900 orders were on the books. After a spate of cancellations that number is now closer to 850. Last Tuesday, Chicago-based Boeing said a structural flaw detected during ground tests required additional reinforcement on the Dreamliner, a problem that will delay the plane's first test flight, possibly for months.
Delivery delays can wreak havoc on an airline's ability to plan its routes and schedules. But they also can provide an opening to renegotiate complicated contracts that govern airplane purchases.
Boeing is coming under pressure from its customers to offer fresh concessions. Industry officials say that Boeing has recently stopped discussing compensation terms for delays to the 787 and they speculate the company is waiting until its actual delivery schedule is clear.
"We want to discuss compensation, but Boeing hasn't opened the books," said an official at one Dreamliner customer.
Already, the delays have cost Boeing millions of dollars in penalties and concessions to customers.
"Our focus is always on our customers and as we've done throughout the development program, we will work closely with them regarding the program and the impact of this issue," says a Boeing spokesman.
Even before the recent delays, some airlines were getting frustrated with Boeing's frequent schedule changes. Akbar Al Baker, chief executive of Qatar Airways, threatened to cancel orders for both 787s and larger 777s, which are now in production, because of disruption caused by problems at Boeing.
"Boeing doesn't realize how much they're hurting their customers' plans," Mr. Al Baker said at the recent Paris Air Show. Qatar Airways has firm orders for 30 787s and options for 30 more. The first were due for delivery in 2011 but that arrival date is now uncertain.
Boeing says its delivery timetable for the aircraft hasn't been updated. A Boeing spokesman said the company was trying to work with Qatar Airways to resolve problems.
Airlines world-wide are struggling with rising oil prices and falling passenger revenue. Fitch Ratings recently downgraded the corporate ratings of UAL Corp. and Delta Air Lines Inc.
Actual cancellations are rare, but last week Australia's Qantas Airways Ltd. said it scratched orders for 15 787s and delayed deliveries on 15 others slated to arrive in 2014-15. Qantas -- which remains the largest Dreamliner airline customer with 50 planes still on the books -- had some leverage to cancel because of its large number of orders, industry observers say. Qantas also retained options to buy dozens more of the planes.
Qantas executives cited a global economy that is far different today than it was when it placed the order in 2005. It said it had been in discussions with Boeing for months.
For Boeing, the cancellations have a silver lining. The jet maker now has a little more breathing room it can use to fill remaining orders more quickly, thereby avoiding some penalties.
"From Boeing's perspective, that's not necessarily bad news when you have a rollout going this poorly," says Peter Barlow, an aviation attorney with Smith, Gambrell & Russell LLP. "The way purchase agreements are drafted, a savvy purchaser will obtain daily damages, and if a plane isn't delivered on time, the customer receives a daily penalty [from the manufacturer] that can be a very big number."
Though the 787's list price is roughly $178 million, customers typically receive discounts. The price negotiated at the time of the order is rarely the price paid when the plane is delivered years later.
Typically, customers make "pre-delivery payments" every six months, beginning about 18 months prior to delivery, that amount to around 30% of the total purchase price. Payments often escalate as the delivery date approaches, says Mr. Barlow. Everything in that process is negotiable, Mr. Barlow says.
Several carriers, including Air New Zealand Ltd., British Airways PLC and Virgin Atlantic Airways Ltd., are coping with 787 delays by ordering current-model planes from either Boeing or Airbus, a unit of European Aeronautic Defence & Space Co.
Virgin, for example, last Monday announced an order for 10 Airbus A330s, which are slightly larger than Dreamliners and not as cutting-edge, but are available next year and in 2011.
"We weren't prepared to have six years of no new aircraft being delivered," said Virgin spokesman Paul Charles. He said Virgin is still talking to Boeing about compensation.
"We would like to see the compensation reflect the ongoing delays," Mr. Charles said.
Ethiopian Airlines, one of the first airlines to order 787s, has kept its order even after bank-financing that it had arranged fell apart, according to a banker familiar with the situation. The airline will instead initially finance its purchase with its own cash, this person said.
Officials at Ethiopian Airlines didn't respond to requests for comment.
—Susan Carey and Stefania Bianchi contributed to this article
Write to Peter Sanders at peter.sanders@wsj.com and Daniel Michaels at daniel.michaels@wsj.com
The latest delay to hit Boeing Co.'s 787 Dreamliner has complicated an intricate set of negotiations, giving airlines a chance to wrangle concessions from the plane maker on delivery dates, installment payments and even the final purchase price.
Already nearly two years behind schedule, the Dreamliner was the fastest selling commercial airplane in Boeing history -- at one point over 900 orders were on the books. After a spate of cancellations that number is now closer to 850. Last Tuesday, Chicago-based Boeing said a structural flaw detected during ground tests required additional reinforcement on the Dreamliner, a problem that will delay the plane's first test flight, possibly for months.
Delivery delays can wreak havoc on an airline's ability to plan its routes and schedules. But they also can provide an opening to renegotiate complicated contracts that govern airplane purchases.
Boeing is coming under pressure from its customers to offer fresh concessions. Industry officials say that Boeing has recently stopped discussing compensation terms for delays to the 787 and they speculate the company is waiting until its actual delivery schedule is clear.
"We want to discuss compensation, but Boeing hasn't opened the books," said an official at one Dreamliner customer.
Already, the delays have cost Boeing millions of dollars in penalties and concessions to customers.
"Our focus is always on our customers and as we've done throughout the development program, we will work closely with them regarding the program and the impact of this issue," says a Boeing spokesman.
Even before the recent delays, some airlines were getting frustrated with Boeing's frequent schedule changes. Akbar Al Baker, chief executive of Qatar Airways, threatened to cancel orders for both 787s and larger 777s, which are now in production, because of disruption caused by problems at Boeing.
"Boeing doesn't realize how much they're hurting their customers' plans," Mr. Al Baker said at the recent Paris Air Show. Qatar Airways has firm orders for 30 787s and options for 30 more. The first were due for delivery in 2011 but that arrival date is now uncertain.
Boeing says its delivery timetable for the aircraft hasn't been updated. A Boeing spokesman said the company was trying to work with Qatar Airways to resolve problems.
Airlines world-wide are struggling with rising oil prices and falling passenger revenue. Fitch Ratings recently downgraded the corporate ratings of UAL Corp. and Delta Air Lines Inc.
Actual cancellations are rare, but last week Australia's Qantas Airways Ltd. said it scratched orders for 15 787s and delayed deliveries on 15 others slated to arrive in 2014-15. Qantas -- which remains the largest Dreamliner airline customer with 50 planes still on the books -- had some leverage to cancel because of its large number of orders, industry observers say. Qantas also retained options to buy dozens more of the planes.
Qantas executives cited a global economy that is far different today than it was when it placed the order in 2005. It said it had been in discussions with Boeing for months.
For Boeing, the cancellations have a silver lining. The jet maker now has a little more breathing room it can use to fill remaining orders more quickly, thereby avoiding some penalties.
"From Boeing's perspective, that's not necessarily bad news when you have a rollout going this poorly," says Peter Barlow, an aviation attorney with Smith, Gambrell & Russell LLP. "The way purchase agreements are drafted, a savvy purchaser will obtain daily damages, and if a plane isn't delivered on time, the customer receives a daily penalty [from the manufacturer] that can be a very big number."
Though the 787's list price is roughly $178 million, customers typically receive discounts. The price negotiated at the time of the order is rarely the price paid when the plane is delivered years later.
Typically, customers make "pre-delivery payments" every six months, beginning about 18 months prior to delivery, that amount to around 30% of the total purchase price. Payments often escalate as the delivery date approaches, says Mr. Barlow. Everything in that process is negotiable, Mr. Barlow says.
Several carriers, including Air New Zealand Ltd., British Airways PLC and Virgin Atlantic Airways Ltd., are coping with 787 delays by ordering current-model planes from either Boeing or Airbus, a unit of European Aeronautic Defence & Space Co.
Virgin, for example, last Monday announced an order for 10 Airbus A330s, which are slightly larger than Dreamliners and not as cutting-edge, but are available next year and in 2011.
"We weren't prepared to have six years of no new aircraft being delivered," said Virgin spokesman Paul Charles. He said Virgin is still talking to Boeing about compensation.
"We would like to see the compensation reflect the ongoing delays," Mr. Charles said.
Ethiopian Airlines, one of the first airlines to order 787s, has kept its order even after bank-financing that it had arranged fell apart, according to a banker familiar with the situation. The airline will instead initially finance its purchase with its own cash, this person said.
Officials at Ethiopian Airlines didn't respond to requests for comment.
—Susan Carey and Stefania Bianchi contributed to this article
Write to Peter Sanders at peter.sanders@wsj.com and Daniel Michaels at daniel.michaels@wsj.com
Sunday, June 28, 2009
Junk Yields Tempt, but Watch Out
--risks to corp bonds
a.large volume issuance of Treasury might increase Treasury yields, disfavoring investment grades
b.weak fundamentals will lead to higher default rate, to the point where yields could not be offset the loss.
c.increasing volume of high yield issuance might increase yield.
Despite Rally, Fundamentals Signal Trouble, Especially on Lower End
By TOM LAURICELLA and JODI XU
Even after a huge junk-bond rally this spring, yields are at historically lofty levels. That might make the high-yield market appear attractive, but some are urging caution.
Record-high defaults, low recoveries on bad loans and a potential wave of new debt suggest the wide yield gap between high-yield bonds and U.S. Treasurys of roughly 11 percentage points is well-deserved. That is especially true for the lowest-quality debt, where a weak economy and credit crunch remain a problem for struggling companies.
"It's going to be quite challenging to do much better," says Edward Altman, a New York University finance professor who specializes in bankruptcy analysis and the high-yield bond market. "The fundamentals are still not strong."
Such an environment should favor buying higher-quality junk bonds and the lower rungs of investment-grade debt -- especially financials -- where yields are still attractive but the ability to raise capital is stronger thanks partly to government help. "You want to pull back on risk and run a more conservative portfolio," says Mark Kiesel, global head of the corporate-bond portfolio group at Pacific Investment Management Co.
A quality focus would be the opposite of the strategy that has worked best since high-yield debt hit bottom starting late last year. While the broad high-yield bond market rallied 42% from its lows, debt rated triple-C by Standard & Poor's posted gains of 65% before falling a bit in recent days, according to Merrill Lynch. In contrast, double-B-rated debt, the upper end of the junk-bond spectrum, gained 35% from its trough. Investors chased the junk-bond rally by pouring money into high-yield-bond mutual funds, which have taken in more than $9 billion since March, according to Morningstar Inc.
The quality-emphasis approach has its risks. Investment-grade bonds move more in tandem with U.S. Treasurys than high yield. Junk bonds closely track stocks. Should the economy show real signs of improvement, stocks stage another rally and Treasurys fall, a higher-quality corporate-bond portfolio could lag.
For now, stocks are closing out the first half of 2009 in a relatively tight range after staging a sharp rebound. The Dow Jones Industrial Average finished last week at 8438.39, up 29% from its March 9 low, but is down 6.6% from its 2009 high reached Jan. 2.
To a large degree, junk's biggest rally since 1991 was a reversal of the extremes seen after Lehman Brothers collapsed. "There was an unprecedented fall and an unprecedented rise," Mr. Altman says. "But whenever you're dealing with market psychology and a herd instinct, you get fluctuations that are more dramatic than perhaps the fundamentals would imply."
Mr. Altman expects spreads to rise toward 12 percentage points over Treasurys amid continued heavy defaults. By his calculation, the default rate on high-yield debt rose to 7.2% during the first five months of this year from 4.6% in 2008, which is roughly the long-term average. He expects the default rate to hit a record 14% one year from now.
Even if the economy recovers during the second half of the year, "I don't think the default rate is going to trail down," he says.
Meanwhile, creditors are recovering a lower proportion of their money in defaults. Mr. Altman forecasts recoveries will be between 20% and 25% for bonds, on par with levels hit during the 2000-2002 collapse of the junk-bond market.
At Metropolitan West, the belief is that the lowest-quality companies are vulnerable after rallying the most. "We find investment-grade financials more appealing," says Tad Rivelle, MetWest's chief investment officer. Banks such as Citigroup are offering historically high yields of 3.5 to four percentage points above Treasurys.
Pimco's Mr. Kiesel also thinks financials are appealing, citing debt issued by J.P. Morgan Chase, Barclays and Rabobank.
Within high yield, Mr. Kiesel is avoiding companies heavily reliant on U.S. consumer spending. Instead he's favoring utilities, health care and cable. In addition, he is slightly biased toward energy and metals, based on the theory that the massive effort by central banks around the globe will result in upward pressure in commodity prices.
Another question mark for high yield is possible heavy issuance of new debt. During April, May and June, nearly $40 billion in high-yield bond offerings came to market. Analysts believe there remains a significant need for companies to raise cash, especially from those looking to shift debt from short-term loans into longer-term maturities. If that pace of issuance were to continue, it would be on par with the record $128 billion issued during 2007.
During the spring rally there was initially little issuance, and subsequently companies found willing buyers for their debt, notes Eric Takaha, a portfolio manager at Franklin Templeton. "To the extent high-yield supply remains high and if you see a larger proportion of that supply coming from somewhat lower-quality issuers, then it will be important that investor demand and cash inflows remain strong," says Mr. Takaha. "Otherwise the supply could then have an incrementally negative impact on the market."
Write to Tom Lauricella at tom.lauricella@wsj.com
a.large volume issuance of Treasury might increase Treasury yields, disfavoring investment grades
b.weak fundamentals will lead to higher default rate, to the point where yields could not be offset the loss.
c.increasing volume of high yield issuance might increase yield.
Despite Rally, Fundamentals Signal Trouble, Especially on Lower End
By TOM LAURICELLA and JODI XU
Even after a huge junk-bond rally this spring, yields are at historically lofty levels. That might make the high-yield market appear attractive, but some are urging caution.
Record-high defaults, low recoveries on bad loans and a potential wave of new debt suggest the wide yield gap between high-yield bonds and U.S. Treasurys of roughly 11 percentage points is well-deserved. That is especially true for the lowest-quality debt, where a weak economy and credit crunch remain a problem for struggling companies.
"It's going to be quite challenging to do much better," says Edward Altman, a New York University finance professor who specializes in bankruptcy analysis and the high-yield bond market. "The fundamentals are still not strong."
Such an environment should favor buying higher-quality junk bonds and the lower rungs of investment-grade debt -- especially financials -- where yields are still attractive but the ability to raise capital is stronger thanks partly to government help. "You want to pull back on risk and run a more conservative portfolio," says Mark Kiesel, global head of the corporate-bond portfolio group at Pacific Investment Management Co.
A quality focus would be the opposite of the strategy that has worked best since high-yield debt hit bottom starting late last year. While the broad high-yield bond market rallied 42% from its lows, debt rated triple-C by Standard & Poor's posted gains of 65% before falling a bit in recent days, according to Merrill Lynch. In contrast, double-B-rated debt, the upper end of the junk-bond spectrum, gained 35% from its trough. Investors chased the junk-bond rally by pouring money into high-yield-bond mutual funds, which have taken in more than $9 billion since March, according to Morningstar Inc.
The quality-emphasis approach has its risks. Investment-grade bonds move more in tandem with U.S. Treasurys than high yield. Junk bonds closely track stocks. Should the economy show real signs of improvement, stocks stage another rally and Treasurys fall, a higher-quality corporate-bond portfolio could lag.
For now, stocks are closing out the first half of 2009 in a relatively tight range after staging a sharp rebound. The Dow Jones Industrial Average finished last week at 8438.39, up 29% from its March 9 low, but is down 6.6% from its 2009 high reached Jan. 2.
To a large degree, junk's biggest rally since 1991 was a reversal of the extremes seen after Lehman Brothers collapsed. "There was an unprecedented fall and an unprecedented rise," Mr. Altman says. "But whenever you're dealing with market psychology and a herd instinct, you get fluctuations that are more dramatic than perhaps the fundamentals would imply."
Mr. Altman expects spreads to rise toward 12 percentage points over Treasurys amid continued heavy defaults. By his calculation, the default rate on high-yield debt rose to 7.2% during the first five months of this year from 4.6% in 2008, which is roughly the long-term average. He expects the default rate to hit a record 14% one year from now.
Even if the economy recovers during the second half of the year, "I don't think the default rate is going to trail down," he says.
Meanwhile, creditors are recovering a lower proportion of their money in defaults. Mr. Altman forecasts recoveries will be between 20% and 25% for bonds, on par with levels hit during the 2000-2002 collapse of the junk-bond market.
At Metropolitan West, the belief is that the lowest-quality companies are vulnerable after rallying the most. "We find investment-grade financials more appealing," says Tad Rivelle, MetWest's chief investment officer. Banks such as Citigroup are offering historically high yields of 3.5 to four percentage points above Treasurys.
Pimco's Mr. Kiesel also thinks financials are appealing, citing debt issued by J.P. Morgan Chase, Barclays and Rabobank.
Within high yield, Mr. Kiesel is avoiding companies heavily reliant on U.S. consumer spending. Instead he's favoring utilities, health care and cable. In addition, he is slightly biased toward energy and metals, based on the theory that the massive effort by central banks around the globe will result in upward pressure in commodity prices.
Another question mark for high yield is possible heavy issuance of new debt. During April, May and June, nearly $40 billion in high-yield bond offerings came to market. Analysts believe there remains a significant need for companies to raise cash, especially from those looking to shift debt from short-term loans into longer-term maturities. If that pace of issuance were to continue, it would be on par with the record $128 billion issued during 2007.
During the spring rally there was initially little issuance, and subsequently companies found willing buyers for their debt, notes Eric Takaha, a portfolio manager at Franklin Templeton. "To the extent high-yield supply remains high and if you see a larger proportion of that supply coming from somewhat lower-quality issuers, then it will be important that investor demand and cash inflows remain strong," says Mr. Takaha. "Otherwise the supply could then have an incrementally negative impact on the market."
Write to Tom Lauricella at tom.lauricella@wsj.com
Saturday, June 27, 2009
Small Banks Not Shying From TARP
By ROBIN SIDEL
Enterprise Bank has one office, three shareholders and $4 million in fresh capital from the U.S. government's Troubled Asset Relief Program.
"That's not a bailout. That's being patriotic," said Chuck Leyh, president and chief executive of the Allison Park, Pa., bank's parent company, Enterprise Financial Services Group. Enterprise Bank, which has $180 million in assets and turned a first-quarter profit of $85,000, plans to funnel the money it got from the Treasury Department on June 12 into loans to fledgling businesses in western Pennsylvania.
In contrast to Wall Street firms like J.P. Morgan Chase & Co., Goldman Sachs Group Inc. and American Express Co. that returned $68.25 billion in one day this month to escape TARP and all the strings that were attached, a steady stream of small banks still is lining up for government money.
Since May 31, 20 small banks have received a total of $164.1 million in taxpayer-funded capital, according to the Treasury's latest available figures. Half of those banks got the money in the same week that 10 big financial institutions gave theirs back.
Analysts see no end in sight to the trend. The recession and borrowers are squeezing most of the 8,200 federally insured commercial banks and savings institutions in the U.S., so even a dollop of TARP funds could make a difference. Some banks are turning to the government to fill a void left by investors who are leery about pouring money into the sector, despite the rebound by bank stocks since early March.
Meanwhile, the rules and stigma of TARP that turned some executives such as J.P. Morgan Chairman and CEO James Dimon against the program are irrelevant to small institutions.
Their employees usually don't fly on corporate jets or collect hefty bonuses that trigger outrage from taxpayers, customers and Congress. And curbs on dividend payments are a modest price to pay for greater assurance that the banks can plow ahead with their core mission to gather local deposits, lend them nearby and support local charities, some recent TARP recipients said.
Still, unflattering headlines and television talking heads that have jabbed at TARP since it was launched last October made some small-bank executives wary about lining up for government money.
Berkshire Bancorp Inc., a five-branch, five-year-old bank in Wyomissing, Pa., with $133 million in assets, raised $3 million from private investors in 2007. Executives were looking for more capital to fuel the bank's growth, deciding to take $2.9 million from TARP on June 12 rather than spend time and money on a capital-raising program that might flop.
Bank officials debated the pros and cons, bracing for tough questions from customers and investors.
"We spent a lot of time with more than 400 shareholders, explaining to them what the plan was and our reasoning behind it," said Norman Heilenman, Berkshire's chairman and chief executive. "There have been a lot of questions, but we haven't had negative reaction."
Without the $15 million River Valley Bancorporation Inc. got two weeks ago, the Wausau, Wis., bank would have been forced to rein in lending. "One of the only other options is to borrow from large banks and, frankly, they're not in the market to do that," said Steve Anderson, president and CEO of River Valley, with $925 million in assets and 18 branches in Michigan and Wisconsin.
Last year, River Valley sold a corporate plane that ferried executives between branches that are about four hours from each other by car.
Smaller TARP recipients have a leg up on big banks that tapped the rescue program. Because small institutions often are closely held, they typically haven't publicly announced getting TARP. Treasury officials publish a spreadsheet that includes a running list of all TARP recipients.
In April, Mark Hanna, president and CEO of Virginia Co. Bank, announced at the Newport News, Va., bank's shareholder meeting that the four-year-old, two-branch bank was approved for $4.7 million in TARP funds. The initial reaction from some investors was negative, but they warmed up after being told that preferred shares issued to the government wouldn't dilute their holdings, he said.
"We haven't received a single customer complaint or comment, but they may not know," Mr. Hanna said.
Overall, 633 U.S. banks have received a total of $199.57 billion in TARP money, according to the Treasury. Of the 32 banks to repay a combined $70.12 billion to the government so far, about 20 are small institutions.
Separately, the Treasury on Friday issued details on the procedures that banks must follow if they want to repurchase warrants that the government received as part of the capital infusions. The 10 big banks that repaid TARP funds earlier this month are wrestling with that issue and must submit their assessment about the value of the warrants by the end of next week.
—Tom McGinty contributed to this article.
Write to Robin Sidel at robin.sidel@wsj.com
Enterprise Bank has one office, three shareholders and $4 million in fresh capital from the U.S. government's Troubled Asset Relief Program.
"That's not a bailout. That's being patriotic," said Chuck Leyh, president and chief executive of the Allison Park, Pa., bank's parent company, Enterprise Financial Services Group. Enterprise Bank, which has $180 million in assets and turned a first-quarter profit of $85,000, plans to funnel the money it got from the Treasury Department on June 12 into loans to fledgling businesses in western Pennsylvania.
In contrast to Wall Street firms like J.P. Morgan Chase & Co., Goldman Sachs Group Inc. and American Express Co. that returned $68.25 billion in one day this month to escape TARP and all the strings that were attached, a steady stream of small banks still is lining up for government money.
Since May 31, 20 small banks have received a total of $164.1 million in taxpayer-funded capital, according to the Treasury's latest available figures. Half of those banks got the money in the same week that 10 big financial institutions gave theirs back.
Analysts see no end in sight to the trend. The recession and borrowers are squeezing most of the 8,200 federally insured commercial banks and savings institutions in the U.S., so even a dollop of TARP funds could make a difference. Some banks are turning to the government to fill a void left by investors who are leery about pouring money into the sector, despite the rebound by bank stocks since early March.
Meanwhile, the rules and stigma of TARP that turned some executives such as J.P. Morgan Chairman and CEO James Dimon against the program are irrelevant to small institutions.
Their employees usually don't fly on corporate jets or collect hefty bonuses that trigger outrage from taxpayers, customers and Congress. And curbs on dividend payments are a modest price to pay for greater assurance that the banks can plow ahead with their core mission to gather local deposits, lend them nearby and support local charities, some recent TARP recipients said.
Still, unflattering headlines and television talking heads that have jabbed at TARP since it was launched last October made some small-bank executives wary about lining up for government money.
Berkshire Bancorp Inc., a five-branch, five-year-old bank in Wyomissing, Pa., with $133 million in assets, raised $3 million from private investors in 2007. Executives were looking for more capital to fuel the bank's growth, deciding to take $2.9 million from TARP on June 12 rather than spend time and money on a capital-raising program that might flop.
Bank officials debated the pros and cons, bracing for tough questions from customers and investors.
"We spent a lot of time with more than 400 shareholders, explaining to them what the plan was and our reasoning behind it," said Norman Heilenman, Berkshire's chairman and chief executive. "There have been a lot of questions, but we haven't had negative reaction."
Without the $15 million River Valley Bancorporation Inc. got two weeks ago, the Wausau, Wis., bank would have been forced to rein in lending. "One of the only other options is to borrow from large banks and, frankly, they're not in the market to do that," said Steve Anderson, president and CEO of River Valley, with $925 million in assets and 18 branches in Michigan and Wisconsin.
Last year, River Valley sold a corporate plane that ferried executives between branches that are about four hours from each other by car.
Smaller TARP recipients have a leg up on big banks that tapped the rescue program. Because small institutions often are closely held, they typically haven't publicly announced getting TARP. Treasury officials publish a spreadsheet that includes a running list of all TARP recipients.
In April, Mark Hanna, president and CEO of Virginia Co. Bank, announced at the Newport News, Va., bank's shareholder meeting that the four-year-old, two-branch bank was approved for $4.7 million in TARP funds. The initial reaction from some investors was negative, but they warmed up after being told that preferred shares issued to the government wouldn't dilute their holdings, he said.
"We haven't received a single customer complaint or comment, but they may not know," Mr. Hanna said.
Overall, 633 U.S. banks have received a total of $199.57 billion in TARP money, according to the Treasury. Of the 32 banks to repay a combined $70.12 billion to the government so far, about 20 are small institutions.
Separately, the Treasury on Friday issued details on the procedures that banks must follow if they want to repurchase warrants that the government received as part of the capital infusions. The 10 big banks that repaid TARP funds earlier this month are wrestling with that issue and must submit their assessment about the value of the warrants by the end of next week.
—Tom McGinty contributed to this article.
Write to Robin Sidel at robin.sidel@wsj.com
Americans Are Saving More, Amid Rising Confidence
By KELLY EVANS
U.S. consumers are saving more of their incomes than any time since 1993 -- a major shift toward frugality that's expected to be one of the lasting effects of this deep and lengthy recession.
Still, consumer sentiment rose for the fifth month in a row in June, a separate report Friday showed, to its highest level since February 2008. The consumer sentiment index, produced by Reuters and the University of Michigan, rose to 70.8 in June from 68.7 in May, though it remains well below its peak of 96.9 in January 2007.
The personal saving rate jumped to 6.9% in May, the Commerce Department said Friday, compared to 5.6% in April. The gain was partly attributable to one-time government payments to eligible seniors made under the Obama administration's economic-stimulus plan intended to spur consumer spending.
But recipients seem unwilling to spend right away. Though the payments helped boost personal income by 1.4% in May, consumer spending -- the main driver of U.S. economic growth -- rose just 0.3% from the prior month.
"The government is doing its job of adding stimulus to the economy in the short run," said Wachovia Corp. chief economist John Lonski. But he said it is not yet clear the plan is having the desired multiplier effect.
Some think the high saving rate will keep a lid on consumer spending and a broader recovery. But for now, the outlook for U.S. growth this year is improving.
Friday's reports cap a week that also showed improvement in business spending last month and a smaller drop in first-quarter economic growth than previously thought. Many economists now expect the recession, which began in December 2007, to end in the third quarter of this year.
There are several obstacles weighing on prospects for a quick recovery. Households are facing the weakest labor market in decades, as the U.S. unemployment rate -- 9.4% as of May -- is likely to march higher when June data are released next Thursday. Roughly 6.7 million workers are drawing weekly unemployment benefits.
"We still expect a subdued recovery," said economists at Barclays Capital in a note Friday.
Write to Kelly Evans at kelly.evans@wsj.com
U.S. consumers are saving more of their incomes than any time since 1993 -- a major shift toward frugality that's expected to be one of the lasting effects of this deep and lengthy recession.
Still, consumer sentiment rose for the fifth month in a row in June, a separate report Friday showed, to its highest level since February 2008. The consumer sentiment index, produced by Reuters and the University of Michigan, rose to 70.8 in June from 68.7 in May, though it remains well below its peak of 96.9 in January 2007.
The personal saving rate jumped to 6.9% in May, the Commerce Department said Friday, compared to 5.6% in April. The gain was partly attributable to one-time government payments to eligible seniors made under the Obama administration's economic-stimulus plan intended to spur consumer spending.
But recipients seem unwilling to spend right away. Though the payments helped boost personal income by 1.4% in May, consumer spending -- the main driver of U.S. economic growth -- rose just 0.3% from the prior month.
"The government is doing its job of adding stimulus to the economy in the short run," said Wachovia Corp. chief economist John Lonski. But he said it is not yet clear the plan is having the desired multiplier effect.
Some think the high saving rate will keep a lid on consumer spending and a broader recovery. But for now, the outlook for U.S. growth this year is improving.
Friday's reports cap a week that also showed improvement in business spending last month and a smaller drop in first-quarter economic growth than previously thought. Many economists now expect the recession, which began in December 2007, to end in the third quarter of this year.
There are several obstacles weighing on prospects for a quick recovery. Households are facing the weakest labor market in decades, as the U.S. unemployment rate -- 9.4% as of May -- is likely to march higher when June data are released next Thursday. Roughly 6.7 million workers are drawing weekly unemployment benefits.
"We still expect a subdued recovery," said economists at Barclays Capital in a note Friday.
Write to Kelly Evans at kelly.evans@wsj.com
Bad Bosses Turn Your Day Job Into A Nightmare
by Alain de Botton
When being interviewed for a job there is rarely a chance at the end to address the issue that, more than any other, will determine our chances of finding happiness in our new position — namely, is my boss sane?
The probability that a boss is well-adjusted is not as high as we might like. Many bosses manifest "paranoid-insecure" patterns of behavior, which make for mood swings, excessive suspicion, anger, inability to focus, over-obsession with status, and a diminished capacity for empathy.
Sadly, these neuroses don't lead people to grow the proverbial horns and a long tail. The boss may look quite normal. For brief moments, especially with clients, he may even act as such. Nevertheless, to those who are in on the story, nothing can entirely disguise that one has placed oneself in the hands of well-dressed maniac.
The first response of the recently hired employee is akin to a new bride who, only a few weeks after toasting her nuptials with 350 friends in a marquee reception with champagne and salmon en croute, is slapped hard across the face by her husband. The forgivable response is to hope and get the blusher out.
The varieties of insanity available to bosses are no less great than those available to parents. There is the overdeveloped desire to be liked, which leads them to shirk candid and prompt explanations of difficulties and to go in for sentimental embraces, which end up causing infinitely more damage than the minor pain they sought to avoid.
Then there is paranoia. How much damage is caused in this world by fragile egos. Whatever the dangers of bumptious overconfidence, they are nothing next to the ravages brought about by a fragile self-esteem. It is this that will cause explosions of rage, intemperate waspish e-mails and snide remarks.
Outwardly we live in a free democracy. But it is in the remit of every insane boss to set up miniature autocratic kingdoms of suffering, unapparent to outside observers, who can see nothing aside from magazines politely lined up in the lobby area.
To those cursed with one, the bad boss is an object of constant thought. One considers the byways of his psyche late into the night. One speculates about his childhood. One hopes for his conversion to humanity. Though it makes no sense, one might even harbor a belief that he might be listening to this and somehow be nudged thereby into turning over a new leaf.
When being interviewed for a job there is rarely a chance at the end to address the issue that, more than any other, will determine our chances of finding happiness in our new position — namely, is my boss sane?
The probability that a boss is well-adjusted is not as high as we might like. Many bosses manifest "paranoid-insecure" patterns of behavior, which make for mood swings, excessive suspicion, anger, inability to focus, over-obsession with status, and a diminished capacity for empathy.
Sadly, these neuroses don't lead people to grow the proverbial horns and a long tail. The boss may look quite normal. For brief moments, especially with clients, he may even act as such. Nevertheless, to those who are in on the story, nothing can entirely disguise that one has placed oneself in the hands of well-dressed maniac.
The first response of the recently hired employee is akin to a new bride who, only a few weeks after toasting her nuptials with 350 friends in a marquee reception with champagne and salmon en croute, is slapped hard across the face by her husband. The forgivable response is to hope and get the blusher out.
The varieties of insanity available to bosses are no less great than those available to parents. There is the overdeveloped desire to be liked, which leads them to shirk candid and prompt explanations of difficulties and to go in for sentimental embraces, which end up causing infinitely more damage than the minor pain they sought to avoid.
Then there is paranoia. How much damage is caused in this world by fragile egos. Whatever the dangers of bumptious overconfidence, they are nothing next to the ravages brought about by a fragile self-esteem. It is this that will cause explosions of rage, intemperate waspish e-mails and snide remarks.
Outwardly we live in a free democracy. But it is in the remit of every insane boss to set up miniature autocratic kingdoms of suffering, unapparent to outside observers, who can see nothing aside from magazines politely lined up in the lobby area.
To those cursed with one, the bad boss is an object of constant thought. One considers the byways of his psyche late into the night. One speculates about his childhood. One hopes for his conversion to humanity. Though it makes no sense, one might even harbor a belief that he might be listening to this and somehow be nudged thereby into turning over a new leaf.
Friday, June 26, 2009
Not Enough Audacity
Paul Krugman
When it comes to domestic policy, there are two Barack Obamas.
On one side there’s Barack the Policy Wonk, whose command of the issues — and ability to explain those issues in plain English — is a joy to behold.
But on the other side there’s Barack the Post-Partisan, who searches for common ground where none exists, and whose negotiations with himself lead to policies that are far too weak.
Both Baracks were on display in the president’s press conference earlier this week. First, Mr. Obama offered a crystal-clear explanation of the case for health care reform, and especially of the case for a public option competing with private insurers. “If private insurers say that the marketplace provides the best quality health care, if they tell us that they’re offering a good deal,” he asked, “then why is it that the government, which they say can’t run anything, suddenly is going to drive them out of business? That’s not logical.”
But when asked whether the public option was non-negotiable he waffled, declaring that there are no “lines in the sand.” That evening, Rahm Emanuel met with Democratic senators and told them — well, it’s not clear what he said. Initial reports had him declaring willingness to abandon the public option, but Senator Kent Conrad’s staff later denied that. Still, the impression everyone got was of a White House all too eager to make concessions.
The big question here is whether health care is about to go the way of the stimulus bill.
At the beginning of this year, you may remember, Mr. Obama made an eloquent case for a strong economic stimulus — then delivered a proposal falling well short of what independent analysts (and, I suspect, his own economists) considered necessary. The goal, presumably, was to attract bipartisan support. But in the event, Mr. Obama was able to pick up only three Senate Republicans by making a plan that was already too weak even weaker.
At the time, some of us warned about what might happen: if unemployment surpassed the administration’s optimistic projections, Republicans wouldn’t accept the need for more stimulus. Instead, they’d declare the whole economic policy a failure. And that’s exactly how it’s playing out. With the unemployment rate now almost certain to pass 10 percent, there’s an overwhelming economic case for more stimulus. But as a political matter it’s going to be harder, not easier, to get that extra stimulus now than it would have been to get the plan right in the first place.
The point is that if you’re making big policy changes, the final form of the policy has to be good enough to do the job. You might think that half a loaf is always better than none — but it isn’t if the failure of half-measures ends up discrediting your whole policy approach.
Which brings us back to health care. It would be a crushing blow to progressive hopes if Mr. Obama doesn’t succeed in getting some form of universal care through Congress. But even so, reform isn’t worth having if you can only get it on terms so compromised that it’s doomed to fail.
What will determine the success or failure of reform? Above all, the success of reform depends on successful cost control. We really, really don’t want to get into a position a few years from now where premiums are rising rapidly, many Americans are priced out of the insurance market despite government subsidies, and the cost of health care subsidies is a growing strain on the budget.
And that’s why the public plan is an important part of reform: it would help keep costs down through a combination of low overhead and bargaining power. That’s not an abstract hypothesis, it’s a conclusion based on solid experience. Currently, Medicare has much lower administrative costs than private insurance companies, while federal health care programs other than Medicare (which isn’t allowed to bargain over drug prices) pay much less for prescription drugs than non-federal buyers. There’s every reason to believe that a public option could achieve similar savings.
Indeed, the prospects for such savings are precisely what have the opponents of a public plan so terrified. Mr. Obama was right: if they really believed their own rhetoric about government waste and inefficiency, they wouldn’t be so worried that the public option would put private insurers out of business. Behind the boilerplate about big government, rationing and all that lies the real concern: fear that the public plan would succeed.
So Mr. Obama and Democrats in Congress have to hang tough — no more gratuitous giveaways in the attempt to sound reasonable. And reform advocates have to keep up the pressure to stay on track. Yes, the perfect is the enemy of the good; but so is the not-good-enough-to-work. Health reform has to be done right.
When it comes to domestic policy, there are two Barack Obamas.
On one side there’s Barack the Policy Wonk, whose command of the issues — and ability to explain those issues in plain English — is a joy to behold.
But on the other side there’s Barack the Post-Partisan, who searches for common ground where none exists, and whose negotiations with himself lead to policies that are far too weak.
Both Baracks were on display in the president’s press conference earlier this week. First, Mr. Obama offered a crystal-clear explanation of the case for health care reform, and especially of the case for a public option competing with private insurers. “If private insurers say that the marketplace provides the best quality health care, if they tell us that they’re offering a good deal,” he asked, “then why is it that the government, which they say can’t run anything, suddenly is going to drive them out of business? That’s not logical.”
But when asked whether the public option was non-negotiable he waffled, declaring that there are no “lines in the sand.” That evening, Rahm Emanuel met with Democratic senators and told them — well, it’s not clear what he said. Initial reports had him declaring willingness to abandon the public option, but Senator Kent Conrad’s staff later denied that. Still, the impression everyone got was of a White House all too eager to make concessions.
The big question here is whether health care is about to go the way of the stimulus bill.
At the beginning of this year, you may remember, Mr. Obama made an eloquent case for a strong economic stimulus — then delivered a proposal falling well short of what independent analysts (and, I suspect, his own economists) considered necessary. The goal, presumably, was to attract bipartisan support. But in the event, Mr. Obama was able to pick up only three Senate Republicans by making a plan that was already too weak even weaker.
At the time, some of us warned about what might happen: if unemployment surpassed the administration’s optimistic projections, Republicans wouldn’t accept the need for more stimulus. Instead, they’d declare the whole economic policy a failure. And that’s exactly how it’s playing out. With the unemployment rate now almost certain to pass 10 percent, there’s an overwhelming economic case for more stimulus. But as a political matter it’s going to be harder, not easier, to get that extra stimulus now than it would have been to get the plan right in the first place.
The point is that if you’re making big policy changes, the final form of the policy has to be good enough to do the job. You might think that half a loaf is always better than none — but it isn’t if the failure of half-measures ends up discrediting your whole policy approach.
Which brings us back to health care. It would be a crushing blow to progressive hopes if Mr. Obama doesn’t succeed in getting some form of universal care through Congress. But even so, reform isn’t worth having if you can only get it on terms so compromised that it’s doomed to fail.
What will determine the success or failure of reform? Above all, the success of reform depends on successful cost control. We really, really don’t want to get into a position a few years from now where premiums are rising rapidly, many Americans are priced out of the insurance market despite government subsidies, and the cost of health care subsidies is a growing strain on the budget.
And that’s why the public plan is an important part of reform: it would help keep costs down through a combination of low overhead and bargaining power. That’s not an abstract hypothesis, it’s a conclusion based on solid experience. Currently, Medicare has much lower administrative costs than private insurance companies, while federal health care programs other than Medicare (which isn’t allowed to bargain over drug prices) pay much less for prescription drugs than non-federal buyers. There’s every reason to believe that a public option could achieve similar savings.
Indeed, the prospects for such savings are precisely what have the opponents of a public plan so terrified. Mr. Obama was right: if they really believed their own rhetoric about government waste and inefficiency, they wouldn’t be so worried that the public option would put private insurers out of business. Behind the boilerplate about big government, rationing and all that lies the real concern: fear that the public plan would succeed.
So Mr. Obama and Democrats in Congress have to hang tough — no more gratuitous giveaways in the attempt to sound reasonable. And reform advocates have to keep up the pressure to stay on track. Yes, the perfect is the enemy of the good; but so is the not-good-enough-to-work. Health reform has to be done right.
Thursday, June 25, 2009
Sources: Michael Jackson, King Of Pop, Dies
LOS ANGELES — Singer Michael Jackson, the man known as the King of Pop to legions of fans around the globe, who lived most of his extraordinary life in the public eye, died Thursday in Los Angeles after going into cardiac arrest, sources tell NPR. He was 50 years old.
It used to be that Jackson’s talent was the most compelling thing about him, says music critic Jody Rosen.
“I think ‘I Want You Back’ is one of the greatest pop singles I’ve ever heard,” Rosen says.
A Childhood In The Limelight
“I Want You Back” was the hit single that famously thrust young Michael Jackson and four of his brothers from the Gary, Ind., talent show circuit to world fame. Their grimly focused father put Michael on stage at age 5. The child, says Rosen, somehow channeled the gifts of vastly more seasoned performers.
“He had a very gritty voice at that time, which is strange, given that as he grew older, he started to sing more and more like a pre-pubescent little boy,” Rosen says. “And when he was a pre- pubescent little boy, he was singing like a soul elder statesman.”
The Jackson 5 had four No. 1 singles in a row, as well as a TV show; the group toured constantly. This was all under the guidance of Motown Records founder Berry Gordy, who had a genius for crossover — molding black artists into mainstream stars. But Gordy told NPR’s Liane Hansen in 1994 that young Michael had a regular childhood.
“Oh, we played baseball every week. We did all kinds of fun things,” Gordy said. “I think it’s been over dramatized about his lack of fun, having no childhood. He had a childhood.”
That account is disputed by Jackson biographers.
Rosen says, “There are stories of the Jackson 5 on the road and all the older brothers cavorting with groupies, while young Michael Jackson — 10, 11, 12 years old — sat in a corner and hung out.”
Jackson’s years at Motown were a study in manipulation and control. Like Stevie Wonder and Marvin Gaye before him, Jackson rebelled. He left Motown and took his first adult solo album to another label. But on the surface, Rosen says, Jackson morphed from child star to pop idol with apparent ease.
‘Don’t Stop ‘Til You Get Enough’
“At the time, his transition to adulthood really did seem seamless,” Rosen says. “He was a disco-era prince. This was 1979. He was this beautiful young man, and he was recording these dance songs which married the music of the disco era and the emphasis on party anthems with the feeling of classic soul.”
The break from Motown paid off with a new kind of rhythm and blues, says Jason King, a professor at New York University. King says in Jackson’s album Off the Wall, you can hear a euphoric sense of freedom.
“Absolutely it was his declaration of independence,” King says. “He had a particular vision of himself doing these funk up-tempo dance numbers and the ballads he had done as a child — but to do them on his own.”
With the help of producer Quincy Jones, Off the Wall scored four top 10 hits. But King says for Jackson, that wasn’t enough.
“He wanted to do something that would crossover even more — that was his dream, his ambition,” King says. “All of the major Motown artists had the same ambition, which was upward mobility, crossover — reach as high as you can.”
In 1983, Michael Jackson’s Thriller became the top-selling album in the world. Critic Jody Rosen says Jackson’s restless crossover ambitions were realized with Thriller, especially with “Beat It.”
“Jackson hired Eddie Van Halen — who at the time was hard rock’s reigning guitar hero — to play this goofy heavy metal solo,” Rosen says. “And that also helped get him on MTV, which, prior to that time, had been the domain almost exclusively of white artists.”
Jackson changed MTV for black artists and for music video auteurs, who admired his skill with the medium. But Jason King says Jackson was driven to top his own success.
“[His success] became an impossible goal because Thriller sold such an incredible amount of copies,” King says.
Fall From Grace
Jackson released more records, but sales declined precipitously. Jackson’s music got denser and more baroque, his behavior more erratic. His videos and performances became bloated, multi-million-dollar affairs. And then came the charges of child molestation.
For comedians like Chris Rock, Michael Jackson became a punch line.
“Another kid? That’s like another dead white girl showing up at OJ’s house,” Rock once joked in a comedy routine.
Or an extended riff.
“Another kid, get the [expletive] out here,” Rock said. “Yo, that’s how much we love Michael. We love Michael so much we let the first kid slide.”
We’ve loved Michael Jackson, been horrified by him and we’ve pitied him.
Not long ago, critic Jody Rosen was at a nightclub. Everyone there was too cool to dance. Then the DJ started spinning Michael Jackson’s early hits, one after the other.
“As soon as he started playing those, the dance floor was stampeded,” Rosen says. “The longer it went on, the more ecstatic the crowd got, and everyone was dancing. That’s the image I’d like to remember MJ by: just sheer joy generated by his best music.”
The Michael Jackson in his mind, Rosen says, was not a has-been, a controversy or a joke. He was a genius.
It used to be that Jackson’s talent was the most compelling thing about him, says music critic Jody Rosen.
“I think ‘I Want You Back’ is one of the greatest pop singles I’ve ever heard,” Rosen says.
A Childhood In The Limelight
“I Want You Back” was the hit single that famously thrust young Michael Jackson and four of his brothers from the Gary, Ind., talent show circuit to world fame. Their grimly focused father put Michael on stage at age 5. The child, says Rosen, somehow channeled the gifts of vastly more seasoned performers.
“He had a very gritty voice at that time, which is strange, given that as he grew older, he started to sing more and more like a pre-pubescent little boy,” Rosen says. “And when he was a pre- pubescent little boy, he was singing like a soul elder statesman.”
The Jackson 5 had four No. 1 singles in a row, as well as a TV show; the group toured constantly. This was all under the guidance of Motown Records founder Berry Gordy, who had a genius for crossover — molding black artists into mainstream stars. But Gordy told NPR’s Liane Hansen in 1994 that young Michael had a regular childhood.
“Oh, we played baseball every week. We did all kinds of fun things,” Gordy said. “I think it’s been over dramatized about his lack of fun, having no childhood. He had a childhood.”
That account is disputed by Jackson biographers.
Rosen says, “There are stories of the Jackson 5 on the road and all the older brothers cavorting with groupies, while young Michael Jackson — 10, 11, 12 years old — sat in a corner and hung out.”
Jackson’s years at Motown were a study in manipulation and control. Like Stevie Wonder and Marvin Gaye before him, Jackson rebelled. He left Motown and took his first adult solo album to another label. But on the surface, Rosen says, Jackson morphed from child star to pop idol with apparent ease.
‘Don’t Stop ‘Til You Get Enough’
“At the time, his transition to adulthood really did seem seamless,” Rosen says. “He was a disco-era prince. This was 1979. He was this beautiful young man, and he was recording these dance songs which married the music of the disco era and the emphasis on party anthems with the feeling of classic soul.”
The break from Motown paid off with a new kind of rhythm and blues, says Jason King, a professor at New York University. King says in Jackson’s album Off the Wall, you can hear a euphoric sense of freedom.
“Absolutely it was his declaration of independence,” King says. “He had a particular vision of himself doing these funk up-tempo dance numbers and the ballads he had done as a child — but to do them on his own.”
With the help of producer Quincy Jones, Off the Wall scored four top 10 hits. But King says for Jackson, that wasn’t enough.
“He wanted to do something that would crossover even more — that was his dream, his ambition,” King says. “All of the major Motown artists had the same ambition, which was upward mobility, crossover — reach as high as you can.”
In 1983, Michael Jackson’s Thriller became the top-selling album in the world. Critic Jody Rosen says Jackson’s restless crossover ambitions were realized with Thriller, especially with “Beat It.”
“Jackson hired Eddie Van Halen — who at the time was hard rock’s reigning guitar hero — to play this goofy heavy metal solo,” Rosen says. “And that also helped get him on MTV, which, prior to that time, had been the domain almost exclusively of white artists.”
Jackson changed MTV for black artists and for music video auteurs, who admired his skill with the medium. But Jason King says Jackson was driven to top his own success.
“[His success] became an impossible goal because Thriller sold such an incredible amount of copies,” King says.
Fall From Grace
Jackson released more records, but sales declined precipitously. Jackson’s music got denser and more baroque, his behavior more erratic. His videos and performances became bloated, multi-million-dollar affairs. And then came the charges of child molestation.
For comedians like Chris Rock, Michael Jackson became a punch line.
“Another kid? That’s like another dead white girl showing up at OJ’s house,” Rock once joked in a comedy routine.
Or an extended riff.
“Another kid, get the [expletive] out here,” Rock said. “Yo, that’s how much we love Michael. We love Michael so much we let the first kid slide.”
We’ve loved Michael Jackson, been horrified by him and we’ve pitied him.
Not long ago, critic Jody Rosen was at a nightclub. Everyone there was too cool to dance. Then the DJ started spinning Michael Jackson’s early hits, one after the other.
“As soon as he started playing those, the dance floor was stampeded,” Rosen says. “The longer it went on, the more ecstatic the crowd got, and everyone was dancing. That’s the image I’d like to remember MJ by: just sheer joy generated by his best music.”
The Michael Jackson in his mind, Rosen says, was not a has-been, a controversy or a joke. He was a genius.
Traders Shrug Off Jobs Data, Drive Stocks Higher
By PETER A. MCKAY and GEOFFREY ROGOW
Stocks rallied on Thursday, snapping a four-day losing streak despite signs that the job market remains in dismal health.
The Dow Jones Industrial Average jumped 172.54 points, or 2.1%, to 8472.40, helped by gains for Alcoa, American Express, Home Depot, Merck and Pfizer, all of which rose more than 3.5%. Twenty-nine of the gauge's 30 components ended higher.
Other stock indexes saw equally strong gains. The S&P 500-stock index leapt 19.33 points, or 2.2%, to 920.27, and the Nasdaq Composite Index rose 37.20 points, or 2.1%, to 1829.54.
The market's gains came despite data showing that the ranks of the jobless are still growing. A weekly report from the Labor Department said that the number of workers filing initial claims for unemployment benefits increased 15,000 to 627,000 in the week ended June 20. The number of continuing claims, or those drawn by workers for more than one week in the week ended June 13, climbed 29,000 to 6,738,000, after plunging 126,000 the previous week.
Companies are continuing to make hefty cuts to their payrolls. Kimberly-Clark said Thursday that it plans to cut about 1,600 jobs, primarily from its salaried, non-production work force. Still, shares of the consumer-products giant added 1.9% amid a broad rally in consumer stocks.
Bed Bath & Beyond leapt 9.5% after its earnings topped analysts' expectations.
Matthew Kaufler, portfolio manager at Federated Clover Investment Advisors in Rochester, N.Y., said the market's reaction Bed Bath & Beyond's report is emblematic of a recent eagerness for consolidation in the retail sector, making some stores attractive even though consumers remain on shaky ground. Mr. Kaufler said Bed Bath & Beyond seemed to benefit from the recent bankruptcy of rival Linens 'n Things.
Rising jobless claims did little to dampen the markets, where traders instead focused on bright spots in the housing sector. Simon Constable reports after the bell.
"Where you see capacity shrinking in an industry because competition is going away, there's always potential for higher earnings leverage," or fast-paced growth coming out of a recession, said Mr. Kaufler. "It's one of the things we're always looking for, and there's a good amount of it in some of the retailers right now."
Investors also packed into housing stocks after Lennar posted a wider second-quarter loss but reported a 63% jump in orders -- a trend that traders hungry for positive news on the housing sector took as a signal to buy. Lennar shares rose 18% and the S&P Homebuilders exchange-traded fund soared by 5.1%.
In addition to the focus on earnings reports, the quarter's end has also brought some window dressing, a benefit to the quarter's best performers -- large banks and consumer companies.
Treasury prices rose after the U.S. Treasury conducted a successful auction of $27 billion in notes, the last installment of $104 billion in such sales this week. The two-year note was recently up 6/32 to yield 1.125%. The 10-year note rose 1-10/32 to yield 3.532%. Yields have fallen sharply since climbing near to 4% several weeks ago.
Write to Peter A. McKay at peter.mckay@wsj.com and Geoffrey Rogow at geoffrey.rogow@dowjones.com
Stocks rallied on Thursday, snapping a four-day losing streak despite signs that the job market remains in dismal health.
The Dow Jones Industrial Average jumped 172.54 points, or 2.1%, to 8472.40, helped by gains for Alcoa, American Express, Home Depot, Merck and Pfizer, all of which rose more than 3.5%. Twenty-nine of the gauge's 30 components ended higher.
Other stock indexes saw equally strong gains. The S&P 500-stock index leapt 19.33 points, or 2.2%, to 920.27, and the Nasdaq Composite Index rose 37.20 points, or 2.1%, to 1829.54.
The market's gains came despite data showing that the ranks of the jobless are still growing. A weekly report from the Labor Department said that the number of workers filing initial claims for unemployment benefits increased 15,000 to 627,000 in the week ended June 20. The number of continuing claims, or those drawn by workers for more than one week in the week ended June 13, climbed 29,000 to 6,738,000, after plunging 126,000 the previous week.
Companies are continuing to make hefty cuts to their payrolls. Kimberly-Clark said Thursday that it plans to cut about 1,600 jobs, primarily from its salaried, non-production work force. Still, shares of the consumer-products giant added 1.9% amid a broad rally in consumer stocks.
Bed Bath & Beyond leapt 9.5% after its earnings topped analysts' expectations.
Matthew Kaufler, portfolio manager at Federated Clover Investment Advisors in Rochester, N.Y., said the market's reaction Bed Bath & Beyond's report is emblematic of a recent eagerness for consolidation in the retail sector, making some stores attractive even though consumers remain on shaky ground. Mr. Kaufler said Bed Bath & Beyond seemed to benefit from the recent bankruptcy of rival Linens 'n Things.
Rising jobless claims did little to dampen the markets, where traders instead focused on bright spots in the housing sector. Simon Constable reports after the bell.
"Where you see capacity shrinking in an industry because competition is going away, there's always potential for higher earnings leverage," or fast-paced growth coming out of a recession, said Mr. Kaufler. "It's one of the things we're always looking for, and there's a good amount of it in some of the retailers right now."
Investors also packed into housing stocks after Lennar posted a wider second-quarter loss but reported a 63% jump in orders -- a trend that traders hungry for positive news on the housing sector took as a signal to buy. Lennar shares rose 18% and the S&P Homebuilders exchange-traded fund soared by 5.1%.
In addition to the focus on earnings reports, the quarter's end has also brought some window dressing, a benefit to the quarter's best performers -- large banks and consumer companies.
Treasury prices rose after the U.S. Treasury conducted a successful auction of $27 billion in notes, the last installment of $104 billion in such sales this week. The two-year note was recently up 6/32 to yield 1.125%. The 10-year note rose 1-10/32 to yield 3.532%. Yields have fallen sharply since climbing near to 4% several weeks ago.
Write to Peter A. McKay at peter.mckay@wsj.com and Geoffrey Rogow at geoffrey.rogow@dowjones.com
Checkout Time: Once-Hot Hotel Deals Cool
By KRIS HUDSON and ANTON TROIANOVSKI
On Tuesday morning, time-share salesman Albert Mora was waiting to meet potential buyers of a Tahiti Village time-share for a tour of the Las Vegas property when a fellow employee got a cryptic call from headquarters to turn away all buyers.
Staff members scurried down the stairs with bundles of cash to return deposits of those being given tours. Later in the day, Mr. Mora learned that Tahiti Village's owner, Consolidated Resorts Inc., which is owned by a Goldman Sachs Group Inc. real-estate fund, was filing for bankruptcy-court protection.
Managers of the fund, part of Goldman's Whitehall real-estate private-equity franchise, had decided to walk away from the $372 million investment, two years after the deal closed.
The chaotic fall of time-share developer Consolidated is the latest example of how Wall Street's foray into the lodging industry is turning out to be a big bust.
Just a few years ago, investors were paying top dollar to acquire hospitality companies on the assumption that demand for time-shares, room rates and travel budgets would continue to rise for the foreseeable future. After all, they reasoned, the industry rebounded quickly after the terrorist attacks on Sept. 11, 2001.
In a prepared statement Tuesday, Consolidated said it planned to file for bankruptcy protection because of a lending environment that "has made it impossible to continue this company."
The country's biggest time-share developers also have seen their business sputter. At Wyndham Worldwide Corp., the biggest time-share developer in the U.S., "vacation ownership" sales plunged to $280 million in the first quarter of 2009, down 39% from a year earlier. Marriott International Inc. reported a first-quarter operating loss of $17 million in its time-share business.
Now, travel budgets are being slashed and room rates are falling, leaving some hotels without enough cash flow to cover their expenses. In the first five months of this year, U.S. hotel occupancy declined to 53%, the lowest total since Smith Travel Research began tracking the figures in 1987. Revenue per available room, on average, has declined to $52.78 so far this year, the lowest tally since 2004.
While all types of hotels are struggling in this recession -- from luxury to budget, from big to small -- the most imperiled are hotel chains that own lots of real estate and were purchased at the top of the market from 2005 to 2008, with substantial debt.
Twenty of the largest hotel buyouts completed between 2005 and 2008 amounted cumulative debt and equity payments of more than $60 billion. Among them: Blackstone Group LP's $26 billion purchase of Hilton Hotels, Lightstone Group's $8 billion purchase of Extended Stay Hotels and the $2.2 billion purchase of Equity Inns Inc. by Goldman's Whitehall.
While not all of those deals are in danger of collapsing, many are troubled. "If you bought a hotel in 2007 and leveraged it to 80% or greater, you just have a huge challenge on your hands," said Bruce Ford, senior vice president of Lodging Econometrics, a hotel-industry research company.
In turn, defaults on hotel loans have risen sharply. Defaults of securitized mortgages -- mortgages chopped up and sold to investors as bonds -- with hotels pledged as collateral likely will rise from the current 4.7% rate to exceed 8% by year end, according to Morgan Stanley.
Already this year, Extended Stay filed for bankruptcy June 15; Red Roof Inn Inc. defaulted on $367 million of securitized mortgages this month, and Whitehall told investors in March it might need a cash infusion or to sell assets to pare Equity Inns' debt.
Monty Bennett, chief executive of Ashford Hospitality Trust Inc., a real-estate investment trust that owns hotels, waded into the deal frenzy when Ashford bought 51 hotels as part of the break-up of fellow REIT CNL Hotels & Resorts Inc. in 2007. While the $2.4 billion Ashford paid was hefty, it was less on a comparative basis than buyers paid in many other hotel buyouts at the time, Mr. Bennett said.
Ashford protected itself from high interest costs on the debt it used to buy the CNL hotels by replacing it with a floating-rate debt. Ashford also sold new shares to raise money to pay down the debt it incurred in the deal. Still, Ashford's stock is down 54% in the past year, though it has fared better than the stocks of other hotel REITs.
—Lingling Wei contributed to this article.
Write to Kris Hudson at kris.hudson@wsj.com and Anton Troianovski at anton.troianovski@wsj.com
On Tuesday morning, time-share salesman Albert Mora was waiting to meet potential buyers of a Tahiti Village time-share for a tour of the Las Vegas property when a fellow employee got a cryptic call from headquarters to turn away all buyers.
Staff members scurried down the stairs with bundles of cash to return deposits of those being given tours. Later in the day, Mr. Mora learned that Tahiti Village's owner, Consolidated Resorts Inc., which is owned by a Goldman Sachs Group Inc. real-estate fund, was filing for bankruptcy-court protection.
Managers of the fund, part of Goldman's Whitehall real-estate private-equity franchise, had decided to walk away from the $372 million investment, two years after the deal closed.
The chaotic fall of time-share developer Consolidated is the latest example of how Wall Street's foray into the lodging industry is turning out to be a big bust.
Just a few years ago, investors were paying top dollar to acquire hospitality companies on the assumption that demand for time-shares, room rates and travel budgets would continue to rise for the foreseeable future. After all, they reasoned, the industry rebounded quickly after the terrorist attacks on Sept. 11, 2001.
In a prepared statement Tuesday, Consolidated said it planned to file for bankruptcy protection because of a lending environment that "has made it impossible to continue this company."
The country's biggest time-share developers also have seen their business sputter. At Wyndham Worldwide Corp., the biggest time-share developer in the U.S., "vacation ownership" sales plunged to $280 million in the first quarter of 2009, down 39% from a year earlier. Marriott International Inc. reported a first-quarter operating loss of $17 million in its time-share business.
Now, travel budgets are being slashed and room rates are falling, leaving some hotels without enough cash flow to cover their expenses. In the first five months of this year, U.S. hotel occupancy declined to 53%, the lowest total since Smith Travel Research began tracking the figures in 1987. Revenue per available room, on average, has declined to $52.78 so far this year, the lowest tally since 2004.
While all types of hotels are struggling in this recession -- from luxury to budget, from big to small -- the most imperiled are hotel chains that own lots of real estate and were purchased at the top of the market from 2005 to 2008, with substantial debt.
Twenty of the largest hotel buyouts completed between 2005 and 2008 amounted cumulative debt and equity payments of more than $60 billion. Among them: Blackstone Group LP's $26 billion purchase of Hilton Hotels, Lightstone Group's $8 billion purchase of Extended Stay Hotels and the $2.2 billion purchase of Equity Inns Inc. by Goldman's Whitehall.
While not all of those deals are in danger of collapsing, many are troubled. "If you bought a hotel in 2007 and leveraged it to 80% or greater, you just have a huge challenge on your hands," said Bruce Ford, senior vice president of Lodging Econometrics, a hotel-industry research company.
In turn, defaults on hotel loans have risen sharply. Defaults of securitized mortgages -- mortgages chopped up and sold to investors as bonds -- with hotels pledged as collateral likely will rise from the current 4.7% rate to exceed 8% by year end, according to Morgan Stanley.
Already this year, Extended Stay filed for bankruptcy June 15; Red Roof Inn Inc. defaulted on $367 million of securitized mortgages this month, and Whitehall told investors in March it might need a cash infusion or to sell assets to pare Equity Inns' debt.
Monty Bennett, chief executive of Ashford Hospitality Trust Inc., a real-estate investment trust that owns hotels, waded into the deal frenzy when Ashford bought 51 hotels as part of the break-up of fellow REIT CNL Hotels & Resorts Inc. in 2007. While the $2.4 billion Ashford paid was hefty, it was less on a comparative basis than buyers paid in many other hotel buyouts at the time, Mr. Bennett said.
Ashford protected itself from high interest costs on the debt it used to buy the CNL hotels by replacing it with a floating-rate debt. Ashford also sold new shares to raise money to pay down the debt it incurred in the deal. Still, Ashford's stock is down 54% in the past year, though it has fared better than the stocks of other hotel REITs.
—Lingling Wei contributed to this article.
Write to Kris Hudson at kris.hudson@wsj.com and Anton Troianovski at anton.troianovski@wsj.com
Funds flow out of money markets
By Michael Mackenzie in New York
Published: June 24 2009 19:02 Last updated: June 24 2009 19:02
During the worst days of the credit crisis last year nervous investors piled into US money market funds in a desperate search for safety.
The amount of money parked in these funds reached a peak in the early months of this year. But since March, as risk appetite has increased once again, billions of dollars have been flowing out of the funds – one of the main reasons for the revival of some asset classes in the last few months.
Emerging market equities and bond funds have been winning investment flows at the expense of money funds and developed equity markets, according to EPFR Global, which tracks fund flows and asset allocation data.
“Cash continues moving off the sidelines in search of higher returns and a degree of protection against anticipated dollar weakness,” says Cameron Brandt, senior analyst at EPFR.
Money market assets totalled $3,903bn for the week ending March 11, and since then have steadily dropped. Meanwhile, long- term mutual fund equity inflows resumed during April and have remained positive for domestic and foreign markets according to Investment Company Institute data. Flows into bonds have been positive every month this year and have exceeded equity inflows by a significant margin.
“The decline in money market fund assets since March has been a good sign of improving risk appetite,” says Gerald Lucas, senior investment advisor at Deutsche Bank. “It is one of the barometers to watch.” The total net assets of all US money market funds was $3,674bn for the week ending June 17, down from the prior week’s total of $3,747bn according to ICI data. That figure compares with the current market capitalisation of $7,800bn for the S&P 500.
Some of the recent drop in money market fund assets is explained by companies and individuals paying their taxes in June. Last June for example, assets dropped from $3,540bn to $3,477bn.
The current numbers show that while some $250bn has flowed out of US money funds since the peak earlier this year, the overall preference for safety and earning next to zero yields remains historically high.
“Although the wall of cash has sprung a few leaks, there is still a substantial sum sitting in money market funds,” says Peter Crane, publisher of Money Fund Intelligence.
This partly reflects the evaporation of short-term investment opportunities. The once popular auction rate securities market and structured money fund plans which invested in asset-backed paper have fallen out of favour since the credit crunch began. As people need to park funds in liquid instruments, this helps explain the current substantial level of money market assets.
Until the bankruptcy of Lehman Brothers last September, money market funds were seen as safe cash-like holdings. That view changed when the Reserve Fund saw its assets fall below par, or what is known in the industry as “breaking the buck” and investors lost money. Investors thus pulled money out of funds that invested in riskier assets and raced into safer funds, which focused on Treasuries.
By the start of the year, money market assets surged to an all-time high of $3,919bn, up from $3,159bn at the start of 2008.
However, with the Federal Reserve embracing a zero interest rate policy, returns from money funds have dropped, forcing some managers to cut fees in order to stop their funds from “breaking the buck”.
“It is clear that some investors are looking at higher yields and returns elsewhere,” says Mr Crane.
Much of the flows into bonds in recent months has targeted municipal or local government securities, whose yields surged above Treasuries last year, a significant dislocation given that munis provide some investors with a tax-free return.
Since the start of April, some $16bn has flowed into tax-exempt municipal mutual funds, according to ICI. Thanks to this buying, muni bond prices have risen, with yields returning to more normal levels versus US Treasuries.
“A lot of money has gone into municipals, less so into equities,” says Jim Paulsen, chief investment strategist at Wells Capital Management.
The pace of flows out of money funds into equities could slow in the coming months as investors remain unsure about the “green shoots” of an economic recovery later this year.
“The equity market is waiting to see where the global economy is going,” says Mr Lucas.
The March rally for equity markets in the US, UK and Europe has faltered in recent weeks and key benchmarks have been trading around important support levels.
For equity bulls, the wall of money on the sidelines is a crucial missing ingredient for the stock market.
Mr Ablin says: “These liquidity levels are a harbinger of bullish developments in stocks for the next couple of years.”
While Mr Paulsen concedes “the money mountain has not been dented that much”, he says this mood will eventually change.
“This environment reminds me a lot of what we experienced in 1982, when stocks rose 40 per cent from their lows and paused for several months,” he said. “It was not until 1983, that people bought into the recovery.”
Published: June 24 2009 19:02 Last updated: June 24 2009 19:02
During the worst days of the credit crisis last year nervous investors piled into US money market funds in a desperate search for safety.
The amount of money parked in these funds reached a peak in the early months of this year. But since March, as risk appetite has increased once again, billions of dollars have been flowing out of the funds – one of the main reasons for the revival of some asset classes in the last few months.
Emerging market equities and bond funds have been winning investment flows at the expense of money funds and developed equity markets, according to EPFR Global, which tracks fund flows and asset allocation data.
“Cash continues moving off the sidelines in search of higher returns and a degree of protection against anticipated dollar weakness,” says Cameron Brandt, senior analyst at EPFR.
Money market assets totalled $3,903bn for the week ending March 11, and since then have steadily dropped. Meanwhile, long- term mutual fund equity inflows resumed during April and have remained positive for domestic and foreign markets according to Investment Company Institute data. Flows into bonds have been positive every month this year and have exceeded equity inflows by a significant margin.
“The decline in money market fund assets since March has been a good sign of improving risk appetite,” says Gerald Lucas, senior investment advisor at Deutsche Bank. “It is one of the barometers to watch.” The total net assets of all US money market funds was $3,674bn for the week ending June 17, down from the prior week’s total of $3,747bn according to ICI data. That figure compares with the current market capitalisation of $7,800bn for the S&P 500.
Some of the recent drop in money market fund assets is explained by companies and individuals paying their taxes in June. Last June for example, assets dropped from $3,540bn to $3,477bn.
The current numbers show that while some $250bn has flowed out of US money funds since the peak earlier this year, the overall preference for safety and earning next to zero yields remains historically high.
“Although the wall of cash has sprung a few leaks, there is still a substantial sum sitting in money market funds,” says Peter Crane, publisher of Money Fund Intelligence.
This partly reflects the evaporation of short-term investment opportunities. The once popular auction rate securities market and structured money fund plans which invested in asset-backed paper have fallen out of favour since the credit crunch began. As people need to park funds in liquid instruments, this helps explain the current substantial level of money market assets.
Until the bankruptcy of Lehman Brothers last September, money market funds were seen as safe cash-like holdings. That view changed when the Reserve Fund saw its assets fall below par, or what is known in the industry as “breaking the buck” and investors lost money. Investors thus pulled money out of funds that invested in riskier assets and raced into safer funds, which focused on Treasuries.
By the start of the year, money market assets surged to an all-time high of $3,919bn, up from $3,159bn at the start of 2008.
However, with the Federal Reserve embracing a zero interest rate policy, returns from money funds have dropped, forcing some managers to cut fees in order to stop their funds from “breaking the buck”.
“It is clear that some investors are looking at higher yields and returns elsewhere,” says Mr Crane.
Much of the flows into bonds in recent months has targeted municipal or local government securities, whose yields surged above Treasuries last year, a significant dislocation given that munis provide some investors with a tax-free return.
Since the start of April, some $16bn has flowed into tax-exempt municipal mutual funds, according to ICI. Thanks to this buying, muni bond prices have risen, with yields returning to more normal levels versus US Treasuries.
“A lot of money has gone into municipals, less so into equities,” says Jim Paulsen, chief investment strategist at Wells Capital Management.
The pace of flows out of money funds into equities could slow in the coming months as investors remain unsure about the “green shoots” of an economic recovery later this year.
“The equity market is waiting to see where the global economy is going,” says Mr Lucas.
The March rally for equity markets in the US, UK and Europe has faltered in recent weeks and key benchmarks have been trading around important support levels.
For equity bulls, the wall of money on the sidelines is a crucial missing ingredient for the stock market.
Mr Ablin says: “These liquidity levels are a harbinger of bullish developments in stocks for the next couple of years.”
While Mr Paulsen concedes “the money mountain has not been dented that much”, he says this mood will eventually change.
“This environment reminds me a lot of what we experienced in 1982, when stocks rose 40 per cent from their lows and paused for several months,” he said. “It was not until 1983, that people bought into the recovery.”
The efficient markets theory is as dead as Python's parrot
Published: June 25 2009 03:00 Last updated: June 25 2009 03:00
The efficient markets hypothesis (EMH) is the financial equivalent of Monty Python's dead parrot. No matter how much you point out that it is dead, the believers simply state that it is just resting. In part, this is testament to the high degree of inertia academic theories enjoy. Once a theory has been accepted, it seems to take forever to dislodge it. As Max Planck observed: "Science advances one funeral at a time."
The EMH states that all information is reflected in current prices. It is bad enough that the EMH exists as an academic theory (filling student's heads with utter garbage) but the very real damage it does comes from the fact that, as Keynes opined, "practical men are usually the slaves of some defunct economist". The EMH has left us with a long litany of bad ideas that have influenced the very structure of our industry.
For instance, the capital asset pricing model (son of EMH) has left us obsessed with performance measurement. The separation of alpha and beta is at best an irrelevance and at worst a serious distraction from the true nature of investment. Sir John Templeton said it best when he observed: "The aim of investment is maximum real total returns after tax." Yet, instead of focusing on this target, we have spawned an industry (the consultants) that only pigeonholes investors into categories.
The obsession with benchmarking also gives rise to one of the biggest sources of bias in our industry - career risk. For a benchmarked investor, risk is measured as tracking error. This gives rise to homo ovinus - a species concerned purely with where they stand relative to the rest of the crowd. This species is the living embodiment of Keynes' edict that "it is better for reputation to fail conventionally than to succeed unconventionally".
The EMH also lies at the heart of risk management, option pricing theory, the concept of shareholder value and even the regulatory approach (markets know best), all of which have inflicted serious damage on investors.
However, the most insidious aspect of the EMH is the advice it offers as to the sources of outperformance. This may sound oxymoronic but the EMH is actually very clear on how you can outperform. You either need inside information, which is, of course, illegal. Or you need to forecast the future better than everyone else. There isn't a scrap of evidence to suggest that we can actually see the future at all. The desire to outforecast everyone else has sent the investment industry on a wild goose chase for decades.
EMH also tells us that opportunities will be fleeting. Why? Because smart, rational arbitrageurs will eradicate any opportunities swiftly. This is akin to the age-old joke about the economist and his friend walking along the street. The friend points out a $100 bill lying on the pavement. The economist says: "It isn't really there because, if it were, someone would have already picked it up." This mindset encourages investors to focus on the short term (where the opportunities lie, according to EMH) rather than on the long term (where the true informational advantage is likely to lie).
EMH fails dramatically when presented with the real world. The most damning evidence against the EMH scarcely merits discussion in academic circles. The elephant in the room for EMH is the existence of bubbles. So terrified are academics of bubbles that they go to enormous lengths to justify them. Believe it or not, two economists have even written a paper arguing that the Nasdaq wasn't actually a bubble when the composite index rose above 5,000 at the start of this decade.
Fund management firm GMO defines a bubble as at least a two standard deviation move from (real) trend. Under EMH, two standard deviation events should occur roughly every 44 years. However, GMO found some 30 plus bubbles since 1925 - slightly more than one every three years. While the details and technicalities of each episode are different, the underlying dynamics follow a very similar pattern. Ex-ante diagnosis of bubbles is surely the fatal blow to EMH.
Faced with this damning assault, EMH supporters fall back on what they call their "nuclear bomb", the failure of active management to outperform the index. However, if fund managers are all trying to outforecast each other, it is no wonder that they don't outperform. New research shows that career risk (losing your job) and business risk (losing funds under management) are the prime drivers of most professional investors. They don't even try to outperform.
Surely, it is high time to consign EMH and its legacy to the dustbin. Shall we manage it? I'm a pessimist. As JK Galbraith said, financial markets are characterised by "extreme brevity of financial memory . . . there can be few fields of human endeavour in which history counts for so little as in the world of finance".
James Montier is global strategist at Société Générale. His new book "Value Investing" will be published in October by Wiley.
The efficient markets hypothesis (EMH) is the financial equivalent of Monty Python's dead parrot. No matter how much you point out that it is dead, the believers simply state that it is just resting. In part, this is testament to the high degree of inertia academic theories enjoy. Once a theory has been accepted, it seems to take forever to dislodge it. As Max Planck observed: "Science advances one funeral at a time."
The EMH states that all information is reflected in current prices. It is bad enough that the EMH exists as an academic theory (filling student's heads with utter garbage) but the very real damage it does comes from the fact that, as Keynes opined, "practical men are usually the slaves of some defunct economist". The EMH has left us with a long litany of bad ideas that have influenced the very structure of our industry.
For instance, the capital asset pricing model (son of EMH) has left us obsessed with performance measurement. The separation of alpha and beta is at best an irrelevance and at worst a serious distraction from the true nature of investment. Sir John Templeton said it best when he observed: "The aim of investment is maximum real total returns after tax." Yet, instead of focusing on this target, we have spawned an industry (the consultants) that only pigeonholes investors into categories.
The obsession with benchmarking also gives rise to one of the biggest sources of bias in our industry - career risk. For a benchmarked investor, risk is measured as tracking error. This gives rise to homo ovinus - a species concerned purely with where they stand relative to the rest of the crowd. This species is the living embodiment of Keynes' edict that "it is better for reputation to fail conventionally than to succeed unconventionally".
The EMH also lies at the heart of risk management, option pricing theory, the concept of shareholder value and even the regulatory approach (markets know best), all of which have inflicted serious damage on investors.
However, the most insidious aspect of the EMH is the advice it offers as to the sources of outperformance. This may sound oxymoronic but the EMH is actually very clear on how you can outperform. You either need inside information, which is, of course, illegal. Or you need to forecast the future better than everyone else. There isn't a scrap of evidence to suggest that we can actually see the future at all. The desire to outforecast everyone else has sent the investment industry on a wild goose chase for decades.
EMH also tells us that opportunities will be fleeting. Why? Because smart, rational arbitrageurs will eradicate any opportunities swiftly. This is akin to the age-old joke about the economist and his friend walking along the street. The friend points out a $100 bill lying on the pavement. The economist says: "It isn't really there because, if it were, someone would have already picked it up." This mindset encourages investors to focus on the short term (where the opportunities lie, according to EMH) rather than on the long term (where the true informational advantage is likely to lie).
EMH fails dramatically when presented with the real world. The most damning evidence against the EMH scarcely merits discussion in academic circles. The elephant in the room for EMH is the existence of bubbles. So terrified are academics of bubbles that they go to enormous lengths to justify them. Believe it or not, two economists have even written a paper arguing that the Nasdaq wasn't actually a bubble when the composite index rose above 5,000 at the start of this decade.
Fund management firm GMO defines a bubble as at least a two standard deviation move from (real) trend. Under EMH, two standard deviation events should occur roughly every 44 years. However, GMO found some 30 plus bubbles since 1925 - slightly more than one every three years. While the details and technicalities of each episode are different, the underlying dynamics follow a very similar pattern. Ex-ante diagnosis of bubbles is surely the fatal blow to EMH.
Faced with this damning assault, EMH supporters fall back on what they call their "nuclear bomb", the failure of active management to outperform the index. However, if fund managers are all trying to outforecast each other, it is no wonder that they don't outperform. New research shows that career risk (losing your job) and business risk (losing funds under management) are the prime drivers of most professional investors. They don't even try to outperform.
Surely, it is high time to consign EMH and its legacy to the dustbin. Shall we manage it? I'm a pessimist. As JK Galbraith said, financial markets are characterised by "extreme brevity of financial memory . . . there can be few fields of human endeavour in which history counts for so little as in the world of finance".
James Montier is global strategist at Société Générale. His new book "Value Investing" will be published in October by Wiley.
Wednesday, June 24, 2009
Credit Cards Chargeoff Rise to 10.62%
From Reuters
The U.S. monthly credit card chargeoff rate surpassed 10 percent and hit a sixth straight record high in May, Moody's Investors Services said on Wednesday, as unemployment grew to a 26-year high.
The chargeoff rate index -- which measures credit card loans the banks do not expect to be repaid -- rose to 10.62 percent in May from 9.97 percent in April.
"We expect the chargeoff rate index to continue to rise in the coming months but at a slower pace, as it peaks at around 12 percent in the second quarter of 2010," Moody's senior vice president William Black said in a statement.
The Moody's index also showed delinquencies -- monthly payments more than 30 days late -- fell to 5.97 percent in May from 6.34 percent in April.
However, the agency said it was due to a seasonal trend, as consumers used tax refunds to pay back debts, and estimated delinquencies will resume their upward trend.
The U.S. monthly credit card chargeoff rate surpassed 10 percent and hit a sixth straight record high in May, Moody's Investors Services said on Wednesday, as unemployment grew to a 26-year high.
The chargeoff rate index -- which measures credit card loans the banks do not expect to be repaid -- rose to 10.62 percent in May from 9.97 percent in April.
"We expect the chargeoff rate index to continue to rise in the coming months but at a slower pace, as it peaks at around 12 percent in the second quarter of 2010," Moody's senior vice president William Black said in a statement.
The Moody's index also showed delinquencies -- monthly payments more than 30 days late -- fell to 5.97 percent in May from 6.34 percent in April.
However, the agency said it was due to a seasonal trend, as consumers used tax refunds to pay back debts, and estimated delinquencies will resume their upward trend.
Fed Statement Following June Meeting
By WSJ Staff
The following is the full text of the Fed’s statement after the June meeting.
Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.
The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.
In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
The following is the full text of the Fed’s statement after the June meeting.
Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.
The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.
In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
Temporary Upside Risks, but Still a Slow Recovery
June 24, 2009
By Richard Berner New York
Investors have taken cheer from less-bad US economic news over the past few months, but the recent stalling in both equity and credit markets suggests that more positive data are needed to extend the rallies that began in March. In the immediate short run, market participants may get their wish: Relative to expectations, we think there are some near-term upside risks to US economic growth. They are concentrated in severely depressed industries such as housing and motor vehicles, as financial conditions have become less restrictive and as inventory liquidation and job loss become less intense.
Even if those improvements materialize, they likely will be fleeting and don't change the overriding dynamic of a slow recovery. Headwinds include consumer deleveraging, still-restrictive financial conditions, budget woes at state and local governments, and cyclical weakness in capital spending and US exports. In addition, if the back-up in mortgage rates and in energy quotes persists, it will reinforce the slow growth dynamic.
If these upside risks are likely to be temporary, why not consider them just noise? First, market participants may be encouraged by any positive data and extrapolate them into a more bullish story. Instead, we would view them as part of the inherently bumpy process of bottoming in the economy, and would note that our call for the end of recession is quite different from calling for even a moderately robust recovery. Second, we expect that Fed officials will look through them and continue their focus on a tepid medium-term economic picture that does not indicate a need for restraint any time soon.
Near-Term Upside Risks...
Though they are likely to remain depressed, housing and motor vehicles are showing a faint pulse. Housing is getting support from the first-time homebuyer tax credit, the lagged effects of lower mortgage rates and home price declines. First enacted in 2008, the tax credit was expanded for homes purchased in 2009 to the lesser of 10% of the purchase price or US$8,000 for first-time buyers of a principal residence with income up to US$150,000 (married, filing jointly). The credit is fully refundable; someone with no taxable income who qualifies as a first-time homebuyer may file for the sole purpose of claiming the credit for a refund, according to the IRS. Although they are still below where they stood in November, mortgage rates have backed up more than 80bp from historical lows since the beginning of June. Still, the lagged effects of the declines in mortgage rates earlier this year have yet to show up fully in housing demand data. Finally, the decline in home prices will continue to improve affordability for many. The result: Despite lingering imbalances between supply and demand in housing, further small gains in sales and starts seem likely in the next few months.
Likewise, less restrictive financial conditions, benefits from ‘cash for clunkers', and restocking should help vehicle sales and possibly output. The captive finance companies have raised loan-to-value ratios to 89% from 85%, improving vehicle affordability; that may reflect the finance arms' ability to securitize TALF-eligible loans. Passage of the cash for clunkers bill - which will offer incentives of US$3,500-4,500 for purchasing fuel-efficient vehicles - will also help. Both the window and the budgeted amount in the current bill are limited: To qualify, buyers must purchase between July 1 and November 1, and only US$1 billion has so far been set aside (good for about 250,000 unit sales). But that ‘use it or lose it' timeframe could create a temporary sales surge - one that borrows from the future (see Cash for Clunkers: Not Much Bang for the Buck, April 24, 2009).
The outlook for vehicle output, which is what matters for GDP, is more uncertain. With two major OEMs in bankruptcy, it is difficult to forecast with any degree of confidence. While GM may put 14 plants on extended vacation this summer, Chrysler is restarting shuttered plants, and Toyota and other nameplates are reportedly poised to step up production. Reflecting these cross-currents, our autos team is expecting a 40% increase in 2H09 production to 2.6 million units; unless sales improve a lot, anything close to that step-up will simply build unwanted inventories. The upshot is that changes in vehicle output are a wildcard for the near-term outlook.
Turning back to demand, consumer spending could show slightly more growth in the coming months. The near-term forces are mixed: On the plus side, more than 50 million Social Security and Supplemental Security Income (SSI) beneficiaries received one-time checks of US$250 in May and June, giving a boost to discretionary income. But each penny increase in gasoline prices boosts fuel costs by US$1.3 billion. Thus, after seasonal adjustment, rising energy costs through June are acting like a US$50 billion tax hike, offsetting the Making Work Pay tax credit that reduced withheld taxes effective April 1. And the back-up in mortgage rates has closed the window on and limited the cash flow benefits to consumers from mortgage refinancing; that benefit seems likely to be only one-quarter of the estimated US$100 billion windfall that would have occurred if conventional mortgage rates had fallen to and stayed near 4.5%.
Finally, recent data suggest a near-term improvement in output, employment and business conditions. Improved financial conditions and rising commodity prices have dramatically reduced the cost of carrying materials inventories, hinting that restocking in those products could lift domestic output or at least temper the declines, as has been the case in Asia. Initial and continuing claims for unemployment insurance have peaked, at least for now, and thus job losses in June (excluding the loss of 50,000 census workers) probably declined to the slowest pace since August 2008. And the evidence from business surveys, such as the ISM and our own MSBCI, points to improving business conditions. The MSBCI moved above 50% in May and improved further in early June for the strongest performance in three years.
...but Slow Recovery Dynamic Persists
Despite these positive signs, the economy is unlikely to get beyond a slow recovery for several reasons. First, housing imbalances are still evident, fueling further declines in home prices, corresponding reluctance by lenders to reduce required down-payments, and further increases in mortgage foreclosures. Homeowner vacancies dipped nationwide in 1Q to an 18-month low of 2.7%, but remain a full percentage point above past norms. Home prices may be bottoming in what had been bubble metro areas, as foreclosure sales are turning up bargains, but they have only begun to decline in previously immune areas. Falling home prices and uncertainty about employment are still persuading consumers to save more out of those stimulus checks and current income and to keep deleveraging their balance sheets (see Deleveraging the American Consumer, May 27, 2009).
In addition, credit terms and conditions are still relatively restrictive, and the combination of tighter risk controls and new regulations will probably keep credit availability below historical norms. The Credit Cardholders' Bill of Rights Act of 2009 passed in May should reduce the inappropriate lending of the past few years, but its restrictions also seem likely to restrict access to credit and make it more costly for the typical consumer. Likewise, if enacted, the Administration's just-proposed plans for financial regulatory reform would not derail the progress made in restarting securitization markets but will likely limit the recovery in more leveraged forms of credit extensions, such as leveraged loans and CMBS, that contributed to the boom.
Third, domestic and global cyclical forces are depressing capital spending and US exports. In the business sector, record-low operating rates and margin pressure are prompting firms to cut capital spending and continue liquidating top-heavy inventories (see Capex Bust and Capital Exit, April 20, 2009). A slow-growth global recovery is likely to persist into 2010 (see Global Forecast Snapshots, June 18, 2009).
Fourth, state and municipal governments are cutting spending and raising taxes despite federal assistance. According to a survey by the National Association of State Budget Officers, governors are responding to revenue shortfalls by proposing some US$24 billion in tax hikes in the fiscal year beginning July 1 for all but four states. And the same canvass indicated that state general fund spending may decline by 2.2%, or about US$35 billion, in the coming fiscal year. Finally, if they persist, the back-up in mortgage rates and in energy quotes will reinforce that dynamic.
For their part, Fed officials are likely to look through any near-term improvements in the economy. They are well aware that the actual path of bottoming and economic recovery will likely be far bumpier than the smooth pattern in their forecasts and ours. As a result, they will likely focus on the medium-term forces that will keep the recovery subdued and limit inflation risks, pushing any policy tightening into 2010 (see The Two Sides of the Inflation Debate, June 15, 2009). Their key challenge lies in communicating the balance between retaining their accommodative stance for an extended period and the need to clarify how and under what circumstances they will exit from quantitative easing and zero interest rates.
To be sure, the Fed's forecast revisions will probably be positive, reflecting the tone of incoming data, and that may limit their willingness to do more to counteract downside risks for output and inflation. But it will take far more positive evidence and a change in underlying forces to improve their fundamental outlook and alter their perception of the appropriate policy response. Indeed, with core inflation beginning to moderate again, and legitimate threats to recovery still in evidence, officials have scant reason to turn hawkish. And if and when officials do turn distinctly more positive, those factors afford them ample time - measured in months - to begin considering any shift in policy.
By Richard Berner New York
Investors have taken cheer from less-bad US economic news over the past few months, but the recent stalling in both equity and credit markets suggests that more positive data are needed to extend the rallies that began in March. In the immediate short run, market participants may get their wish: Relative to expectations, we think there are some near-term upside risks to US economic growth. They are concentrated in severely depressed industries such as housing and motor vehicles, as financial conditions have become less restrictive and as inventory liquidation and job loss become less intense.
Even if those improvements materialize, they likely will be fleeting and don't change the overriding dynamic of a slow recovery. Headwinds include consumer deleveraging, still-restrictive financial conditions, budget woes at state and local governments, and cyclical weakness in capital spending and US exports. In addition, if the back-up in mortgage rates and in energy quotes persists, it will reinforce the slow growth dynamic.
If these upside risks are likely to be temporary, why not consider them just noise? First, market participants may be encouraged by any positive data and extrapolate them into a more bullish story. Instead, we would view them as part of the inherently bumpy process of bottoming in the economy, and would note that our call for the end of recession is quite different from calling for even a moderately robust recovery. Second, we expect that Fed officials will look through them and continue their focus on a tepid medium-term economic picture that does not indicate a need for restraint any time soon.
Near-Term Upside Risks...
Though they are likely to remain depressed, housing and motor vehicles are showing a faint pulse. Housing is getting support from the first-time homebuyer tax credit, the lagged effects of lower mortgage rates and home price declines. First enacted in 2008, the tax credit was expanded for homes purchased in 2009 to the lesser of 10% of the purchase price or US$8,000 for first-time buyers of a principal residence with income up to US$150,000 (married, filing jointly). The credit is fully refundable; someone with no taxable income who qualifies as a first-time homebuyer may file for the sole purpose of claiming the credit for a refund, according to the IRS. Although they are still below where they stood in November, mortgage rates have backed up more than 80bp from historical lows since the beginning of June. Still, the lagged effects of the declines in mortgage rates earlier this year have yet to show up fully in housing demand data. Finally, the decline in home prices will continue to improve affordability for many. The result: Despite lingering imbalances between supply and demand in housing, further small gains in sales and starts seem likely in the next few months.
Likewise, less restrictive financial conditions, benefits from ‘cash for clunkers', and restocking should help vehicle sales and possibly output. The captive finance companies have raised loan-to-value ratios to 89% from 85%, improving vehicle affordability; that may reflect the finance arms' ability to securitize TALF-eligible loans. Passage of the cash for clunkers bill - which will offer incentives of US$3,500-4,500 for purchasing fuel-efficient vehicles - will also help. Both the window and the budgeted amount in the current bill are limited: To qualify, buyers must purchase between July 1 and November 1, and only US$1 billion has so far been set aside (good for about 250,000 unit sales). But that ‘use it or lose it' timeframe could create a temporary sales surge - one that borrows from the future (see Cash for Clunkers: Not Much Bang for the Buck, April 24, 2009).
The outlook for vehicle output, which is what matters for GDP, is more uncertain. With two major OEMs in bankruptcy, it is difficult to forecast with any degree of confidence. While GM may put 14 plants on extended vacation this summer, Chrysler is restarting shuttered plants, and Toyota and other nameplates are reportedly poised to step up production. Reflecting these cross-currents, our autos team is expecting a 40% increase in 2H09 production to 2.6 million units; unless sales improve a lot, anything close to that step-up will simply build unwanted inventories. The upshot is that changes in vehicle output are a wildcard for the near-term outlook.
Turning back to demand, consumer spending could show slightly more growth in the coming months. The near-term forces are mixed: On the plus side, more than 50 million Social Security and Supplemental Security Income (SSI) beneficiaries received one-time checks of US$250 in May and June, giving a boost to discretionary income. But each penny increase in gasoline prices boosts fuel costs by US$1.3 billion. Thus, after seasonal adjustment, rising energy costs through June are acting like a US$50 billion tax hike, offsetting the Making Work Pay tax credit that reduced withheld taxes effective April 1. And the back-up in mortgage rates has closed the window on and limited the cash flow benefits to consumers from mortgage refinancing; that benefit seems likely to be only one-quarter of the estimated US$100 billion windfall that would have occurred if conventional mortgage rates had fallen to and stayed near 4.5%.
Finally, recent data suggest a near-term improvement in output, employment and business conditions. Improved financial conditions and rising commodity prices have dramatically reduced the cost of carrying materials inventories, hinting that restocking in those products could lift domestic output or at least temper the declines, as has been the case in Asia. Initial and continuing claims for unemployment insurance have peaked, at least for now, and thus job losses in June (excluding the loss of 50,000 census workers) probably declined to the slowest pace since August 2008. And the evidence from business surveys, such as the ISM and our own MSBCI, points to improving business conditions. The MSBCI moved above 50% in May and improved further in early June for the strongest performance in three years.
...but Slow Recovery Dynamic Persists
Despite these positive signs, the economy is unlikely to get beyond a slow recovery for several reasons. First, housing imbalances are still evident, fueling further declines in home prices, corresponding reluctance by lenders to reduce required down-payments, and further increases in mortgage foreclosures. Homeowner vacancies dipped nationwide in 1Q to an 18-month low of 2.7%, but remain a full percentage point above past norms. Home prices may be bottoming in what had been bubble metro areas, as foreclosure sales are turning up bargains, but they have only begun to decline in previously immune areas. Falling home prices and uncertainty about employment are still persuading consumers to save more out of those stimulus checks and current income and to keep deleveraging their balance sheets (see Deleveraging the American Consumer, May 27, 2009).
In addition, credit terms and conditions are still relatively restrictive, and the combination of tighter risk controls and new regulations will probably keep credit availability below historical norms. The Credit Cardholders' Bill of Rights Act of 2009 passed in May should reduce the inappropriate lending of the past few years, but its restrictions also seem likely to restrict access to credit and make it more costly for the typical consumer. Likewise, if enacted, the Administration's just-proposed plans for financial regulatory reform would not derail the progress made in restarting securitization markets but will likely limit the recovery in more leveraged forms of credit extensions, such as leveraged loans and CMBS, that contributed to the boom.
Third, domestic and global cyclical forces are depressing capital spending and US exports. In the business sector, record-low operating rates and margin pressure are prompting firms to cut capital spending and continue liquidating top-heavy inventories (see Capex Bust and Capital Exit, April 20, 2009). A slow-growth global recovery is likely to persist into 2010 (see Global Forecast Snapshots, June 18, 2009).
Fourth, state and municipal governments are cutting spending and raising taxes despite federal assistance. According to a survey by the National Association of State Budget Officers, governors are responding to revenue shortfalls by proposing some US$24 billion in tax hikes in the fiscal year beginning July 1 for all but four states. And the same canvass indicated that state general fund spending may decline by 2.2%, or about US$35 billion, in the coming fiscal year. Finally, if they persist, the back-up in mortgage rates and in energy quotes will reinforce that dynamic.
For their part, Fed officials are likely to look through any near-term improvements in the economy. They are well aware that the actual path of bottoming and economic recovery will likely be far bumpier than the smooth pattern in their forecasts and ours. As a result, they will likely focus on the medium-term forces that will keep the recovery subdued and limit inflation risks, pushing any policy tightening into 2010 (see The Two Sides of the Inflation Debate, June 15, 2009). Their key challenge lies in communicating the balance between retaining their accommodative stance for an extended period and the need to clarify how and under what circumstances they will exit from quantitative easing and zero interest rates.
To be sure, the Fed's forecast revisions will probably be positive, reflecting the tone of incoming data, and that may limit their willingness to do more to counteract downside risks for output and inflation. But it will take far more positive evidence and a change in underlying forces to improve their fundamental outlook and alter their perception of the appropriate policy response. Indeed, with core inflation beginning to moderate again, and legitimate threats to recovery still in evidence, officials have scant reason to turn hawkish. And if and when officials do turn distinctly more positive, those factors afford them ample time - measured in months - to begin considering any shift in policy.
Behind a Bankruptcy Brouhaha
Extended Stay Hits Snags as Creditors Cry Foul; Lichtenstein as 'Bad Boy'?
By LINGLING WEI and KRIS HUDSON
David Lichtenstein is facing challenges to the plan that took his Extended Stay Hotels chain into bankruptcy protection. At stake for the real-estate investor: Whether the filing could trigger $100 million of personal liability that he has tried to avoid.
The controversy over the bankruptcy filing and Mr. Lichtenstein's potential liability has thrown the commercial-property world into an uproar, because the filing also is laying bare many of the technical features of commercial mortgage-backed securities, or CMBS, that have never before been tested on a large scale. As the Extended Stay case is showing, the protections for investors may be less solid than expected, according to CMBS lawyers and bankers.
The case could have repercussions for the broader economy. Without clarity on their rights and recoveries, hundreds of billions of dollars in CMBS loans could be caught in legal limbo. This could, in turn, hamper banks' ability to clear bad paper off their books and jump-start this $700 billion securitization market, market participants said.
Under a reorganization proposal endorsed by some creditors, including Cerberus Capital Management LP and Centerbridge Partners LP, Extended Stay would wipe out $4.8 billion in existing debt. This stands to benefit holders of the four most-senior slices of Extended Stay CMBS bonds, which were divided into 18 different components. The deal also helps Mr. Lichtenstein because it would indemnify him from making $100 million in "bad-boy" payments. Such payments are supposed to incentivize borrowers to avoid bankruptcy, by making them personally liable for debts owed.
Mr. Lichtenstein declined to comment through his _representative.
Defenders of Extended Stay's bankruptcy filing argue that the complex debt structure made it all but impossible for the company to get all its creditors to agree on a plan. In the days leading up to the filing, the company was running out of money. That left Mr. Lichtenstein with a dilemma, these people said: File for bankruptcy protection and trigger the "bad-boy" clause or close the company and risk being sued for failing to fulfill his duty as a company director.
In all, holders of about one-quarter of the $4.1 billion in first-mortgage debt supported the deal when it was pitched by Extended Stay before it filed for bankruptcy protection last week.
But now, some creditors are saying the deal is invalid. Five Mile Capital Partners LLC, an investor owning $77 million of a junior piece of Extended Stay CMBS bonds, argued in a New York lawsuit that the deal Mr. Lichtenstein struck with creditors, including Cerberus and Centerbridge, awarded these creditors "a higher rate of return" at the expense of other bondholders. The CMBS loan agreement "makes clear that no individual may take any action…in an effort to improve its position vis a vis the positions" of other bondholders, the suit said.
Proponents of the deal argue that the lawsuit has no merit because there is no legal contract binding Cerberus and Centerbridge to the plan proposed by Extended Stay, even though they verbally agreed to it.
For Five Mile and others, this is a technical, but crucial point that undergirds the CMBS market. Under most CMBS loan agreements, a borrower is supposed to negotiate only with an issuer's loan servicer, which is responsible for looking after the interests of all investors. Owners of the most risky slice of the CMBS debt also have special rights to appoint the servicer for the entire group when the debt goes into default. Citigroup Inc., which owns a portion of the $100 million junior-most slice of the Extended Stay CMBS bonds, has appointed TriMont Real Estate Advisors as special servicer.
The likes of Cerberus and Centerbridge had no standing to speak for all the first-mortgage holders, according to the lawsuit. In general, to make any loan modifications, a servicer must win the support of the vast majority, if not 100%, of bondholders, according to lawyers not involved in the case.
"The [bankruptcy] filing surprised no one," said Moody's Investors Service in a report on the deal. "It was who appeared in bankruptcy court claiming to represent the securitized lenders that raised eyebrows." Supporters of the plan said the creditors who agreed to the company's proposal were the only ones who were willing to talk to the company.
This is different from most other situations, where borrowers have latitude to negotiate with whom they choose. And they also can win concessions without unanimous support.
"Back in the 1990s, we were in most cases able to get all the lenders in one room and talk about restructuring," said Alan J. Pomerantz, a partner at law firm Orrick, Herrington & Sutcliffe LLP, who represented bank lenders to Donald Trump and other developers in the last real-estate collapse. "Today, because of the way the CMBS debt was structured, you don't even know who holds the debt if there is a problem."
Extended Stay's woes also highlight the complicated way Mr. Lichtenstein financed his buyout of the 680-property hotel chain from Blackstone Group LP two years ago. Besides the first mortgage, the $8 billion deal was funded with a $3 billion mezzanine, or junior, loan, which also was carved up into slices with different levels of risks and returns. Wachovia Corp., now owned by Wells Fargo & Co., Bear Stearns Cos., Bank of America Corp. and its Merrill Lynch unit provided the original financing and still hold billions of dollars of the debt. Bear's stake was taken over by the Federal Reserve after the firm collapsed in March 2008, potentially exposing U.S. taxpayers to the outcome of the restructuring talks. Defenders of the deal said the company is valued at far less than even its first-mortgage debt, and the proposal is an attempt to salvage some parts of the company. The company itself estimates its value at $3.3 billion.
"Any bankruptcy is a deal where there is not enough money to satisfy everyone," said a person involved in negotiating the transaction. "It simply is not worth the mortgage debt. We are trying to elevate substance over form."
If the court strikes down the proposed restructuring plan, Mr. Lichtenstein could be back on the hook for the $100 million, according to lawyers not involved in the case. That would imperil the rest of his real-estate empire, which includes outlet centers, office buildings and warehouses throughout the country.
—Jeffrey McCracken and Mike Spector contributed to this article.
Write to Lingling Wei at lingling.wei@dowjones.com and Kris Hudson at kris.hudson@wsj.com
By LINGLING WEI and KRIS HUDSON
David Lichtenstein is facing challenges to the plan that took his Extended Stay Hotels chain into bankruptcy protection. At stake for the real-estate investor: Whether the filing could trigger $100 million of personal liability that he has tried to avoid.
The controversy over the bankruptcy filing and Mr. Lichtenstein's potential liability has thrown the commercial-property world into an uproar, because the filing also is laying bare many of the technical features of commercial mortgage-backed securities, or CMBS, that have never before been tested on a large scale. As the Extended Stay case is showing, the protections for investors may be less solid than expected, according to CMBS lawyers and bankers.
The case could have repercussions for the broader economy. Without clarity on their rights and recoveries, hundreds of billions of dollars in CMBS loans could be caught in legal limbo. This could, in turn, hamper banks' ability to clear bad paper off their books and jump-start this $700 billion securitization market, market participants said.
Under a reorganization proposal endorsed by some creditors, including Cerberus Capital Management LP and Centerbridge Partners LP, Extended Stay would wipe out $4.8 billion in existing debt. This stands to benefit holders of the four most-senior slices of Extended Stay CMBS bonds, which were divided into 18 different components. The deal also helps Mr. Lichtenstein because it would indemnify him from making $100 million in "bad-boy" payments. Such payments are supposed to incentivize borrowers to avoid bankruptcy, by making them personally liable for debts owed.
Mr. Lichtenstein declined to comment through his _representative.
Defenders of Extended Stay's bankruptcy filing argue that the complex debt structure made it all but impossible for the company to get all its creditors to agree on a plan. In the days leading up to the filing, the company was running out of money. That left Mr. Lichtenstein with a dilemma, these people said: File for bankruptcy protection and trigger the "bad-boy" clause or close the company and risk being sued for failing to fulfill his duty as a company director.
In all, holders of about one-quarter of the $4.1 billion in first-mortgage debt supported the deal when it was pitched by Extended Stay before it filed for bankruptcy protection last week.
But now, some creditors are saying the deal is invalid. Five Mile Capital Partners LLC, an investor owning $77 million of a junior piece of Extended Stay CMBS bonds, argued in a New York lawsuit that the deal Mr. Lichtenstein struck with creditors, including Cerberus and Centerbridge, awarded these creditors "a higher rate of return" at the expense of other bondholders. The CMBS loan agreement "makes clear that no individual may take any action…in an effort to improve its position vis a vis the positions" of other bondholders, the suit said.
Proponents of the deal argue that the lawsuit has no merit because there is no legal contract binding Cerberus and Centerbridge to the plan proposed by Extended Stay, even though they verbally agreed to it.
For Five Mile and others, this is a technical, but crucial point that undergirds the CMBS market. Under most CMBS loan agreements, a borrower is supposed to negotiate only with an issuer's loan servicer, which is responsible for looking after the interests of all investors. Owners of the most risky slice of the CMBS debt also have special rights to appoint the servicer for the entire group when the debt goes into default. Citigroup Inc., which owns a portion of the $100 million junior-most slice of the Extended Stay CMBS bonds, has appointed TriMont Real Estate Advisors as special servicer.
The likes of Cerberus and Centerbridge had no standing to speak for all the first-mortgage holders, according to the lawsuit. In general, to make any loan modifications, a servicer must win the support of the vast majority, if not 100%, of bondholders, according to lawyers not involved in the case.
"The [bankruptcy] filing surprised no one," said Moody's Investors Service in a report on the deal. "It was who appeared in bankruptcy court claiming to represent the securitized lenders that raised eyebrows." Supporters of the plan said the creditors who agreed to the company's proposal were the only ones who were willing to talk to the company.
This is different from most other situations, where borrowers have latitude to negotiate with whom they choose. And they also can win concessions without unanimous support.
"Back in the 1990s, we were in most cases able to get all the lenders in one room and talk about restructuring," said Alan J. Pomerantz, a partner at law firm Orrick, Herrington & Sutcliffe LLP, who represented bank lenders to Donald Trump and other developers in the last real-estate collapse. "Today, because of the way the CMBS debt was structured, you don't even know who holds the debt if there is a problem."
Extended Stay's woes also highlight the complicated way Mr. Lichtenstein financed his buyout of the 680-property hotel chain from Blackstone Group LP two years ago. Besides the first mortgage, the $8 billion deal was funded with a $3 billion mezzanine, or junior, loan, which also was carved up into slices with different levels of risks and returns. Wachovia Corp., now owned by Wells Fargo & Co., Bear Stearns Cos., Bank of America Corp. and its Merrill Lynch unit provided the original financing and still hold billions of dollars of the debt. Bear's stake was taken over by the Federal Reserve after the firm collapsed in March 2008, potentially exposing U.S. taxpayers to the outcome of the restructuring talks. Defenders of the deal said the company is valued at far less than even its first-mortgage debt, and the proposal is an attempt to salvage some parts of the company. The company itself estimates its value at $3.3 billion.
"Any bankruptcy is a deal where there is not enough money to satisfy everyone," said a person involved in negotiating the transaction. "It simply is not worth the mortgage debt. We are trying to elevate substance over form."
If the court strikes down the proposed restructuring plan, Mr. Lichtenstein could be back on the hook for the $100 million, according to lawyers not involved in the case. That would imperil the rest of his real-estate empire, which includes outlet centers, office buildings and warehouses throughout the country.
—Jeffrey McCracken and Mike Spector contributed to this article.
Write to Lingling Wei at lingling.wei@dowjones.com and Kris Hudson at kris.hudson@wsj.com
Durable-Goods Orders Jump 1.8%
--New orders for durable goods increased 1.8%, ex-trans 1.1%
--Manufactures are still slashing inventory, 0.8% in May
By JEFF BATER
WASHINGTON -- Demand for expensive goods made a strong, surprising increase in May, the third climb in four months, while a gauge of capital spending surged by the most in nearly five years.
Manufacturers' orders for durable goods increased by 1.8% last month to a seasonally adjusted $163.92 billion, the Commerce Department said Wednesday.
Wall Street expected a big decrease. Economists surveyed by Dow Jones Newswires had projected orders in May would fall 0.8%.
Orders for nondefense capital goods excluding aircraft rose by 4.8%, after decreasing 2.9% in April. It was the largest increase since 8.2% in September 2004. The orders are closely tracked as a gauge of capital spending by businesses. Despite the big May increase, the recession has left the capital orders down sharply year over year. Companies have had difficulty getting financing. The commercial equipment financing sector saw its volume plunge in May, a trade group report Tuesday said. The Equipment Leasing and Finance Association's monthly leasing and finance index fell by 41% compared to May 2008. The group blames tough credit conditions and a tightening of underwriting standards.
Durables are goods designed to last at least three years, such as computers and washing machines. April overall durables also rose 1.8%, revised up from a previously estimated 1.7% increase. Durables year to date are down 26.8%, in unadjusted terms, from the same period in 2008.
While manufacturing is suffering, it, like the entire economy, isn't as bad as it had been. Because companies are purging inventory and not demanding so much and because consumers saddled with debt and afraid of being laid off aren't spending so much, factories have lost a lot of steam. Industrial production fell 1.1% in May. But output was falling at about twice that rate at the end of 2008, when the recession apparently was at its deepest.
Manufacturers are still cutting inventory, Wednesday's data showed. Manufacturers' inventories of durable goods decreased in May 0.8%.
Unfilled manufacturers' orders, a sign of future demand, decreased 0.3%. That's the eighth drop in a row.
Demand for transportation-related durables last month rose 3.6%, after shooting up 6.2% in April. Orders for commercial planes jumped 68.1%. Military aircraft orders fell 1.7%.
Motor vehicles and parts decreased by 8.1%.
Excluding the transportation sector, orders for all other durables climbed by 1.1% in May. Orders rose 7.7% for machinery, 0.2% for primary metals, and 2.2% for computers and electronics. Fabricated metals fell 2.5% and orders dropped 1.1% for electrical equipment.
Demand ex-transportation had climbed 0.4% in April.
May capital goods orders increased by 9.5%. Non-defense capital goods -- items meant to last 10 years or longer -- rose by 10.0%.
Defense-related capital goods orders went up 7.4%. Orders for everything except defense goods increased by 1.4% in May, after going 0.6% higher in April.
Durable-goods shipments of manufacturers fell 2.1% last month.
Write to Jeff Bater at jeff.bater@dowjones.com
--Manufactures are still slashing inventory, 0.8% in May
By JEFF BATER
WASHINGTON -- Demand for expensive goods made a strong, surprising increase in May, the third climb in four months, while a gauge of capital spending surged by the most in nearly five years.
Manufacturers' orders for durable goods increased by 1.8% last month to a seasonally adjusted $163.92 billion, the Commerce Department said Wednesday.
Wall Street expected a big decrease. Economists surveyed by Dow Jones Newswires had projected orders in May would fall 0.8%.
Orders for nondefense capital goods excluding aircraft rose by 4.8%, after decreasing 2.9% in April. It was the largest increase since 8.2% in September 2004. The orders are closely tracked as a gauge of capital spending by businesses. Despite the big May increase, the recession has left the capital orders down sharply year over year. Companies have had difficulty getting financing. The commercial equipment financing sector saw its volume plunge in May, a trade group report Tuesday said. The Equipment Leasing and Finance Association's monthly leasing and finance index fell by 41% compared to May 2008. The group blames tough credit conditions and a tightening of underwriting standards.
Durables are goods designed to last at least three years, such as computers and washing machines. April overall durables also rose 1.8%, revised up from a previously estimated 1.7% increase. Durables year to date are down 26.8%, in unadjusted terms, from the same period in 2008.
While manufacturing is suffering, it, like the entire economy, isn't as bad as it had been. Because companies are purging inventory and not demanding so much and because consumers saddled with debt and afraid of being laid off aren't spending so much, factories have lost a lot of steam. Industrial production fell 1.1% in May. But output was falling at about twice that rate at the end of 2008, when the recession apparently was at its deepest.
Manufacturers are still cutting inventory, Wednesday's data showed. Manufacturers' inventories of durable goods decreased in May 0.8%.
Unfilled manufacturers' orders, a sign of future demand, decreased 0.3%. That's the eighth drop in a row.
Demand for transportation-related durables last month rose 3.6%, after shooting up 6.2% in April. Orders for commercial planes jumped 68.1%. Military aircraft orders fell 1.7%.
Motor vehicles and parts decreased by 8.1%.
Excluding the transportation sector, orders for all other durables climbed by 1.1% in May. Orders rose 7.7% for machinery, 0.2% for primary metals, and 2.2% for computers and electronics. Fabricated metals fell 2.5% and orders dropped 1.1% for electrical equipment.
Demand ex-transportation had climbed 0.4% in April.
May capital goods orders increased by 9.5%. Non-defense capital goods -- items meant to last 10 years or longer -- rose by 10.0%.
Defense-related capital goods orders went up 7.4%. Orders for everything except defense goods increased by 1.4% in May, after going 0.6% higher in April.
Durable-goods shipments of manufacturers fell 2.1% last month.
Write to Jeff Bater at jeff.bater@dowjones.com
Tuesday, June 23, 2009
Sales Slowdown Trims Oracle Profit
By BEN WORTHEN
Oracle Corp. posted a revenue decline for the first time since 2002, hurt by a strong dollar and companies' continued reluctance to spend on new technology projects.
Oracle, a huge provider of software for businesses, is the first large technology company to report results that include the month of May, and investors were looking for signs that the recession is easing. In April and May, tech companies such as Cisco Systems Inc. and Intel Corp. said orders were leveling off and the worst of the recession might be over.
For the fiscal fourth quarter ended May 31, Oracle's profit dropped 7.2% to $1.89 billion and revenue fell 5.2% to $6.86 billion during what is seasonally one of the company's strongest quarters as it offers discounts to close deals before the end of the fiscal year. It was Oracle's largest earnings drop in three years.
Over the quarter, Oracle, which does about half its business overseas, was hit hard by a strong U.S. dollar. In constant currency, its revenue climbed 4%, and income was up 5%.
Sales of new software dropped 13%, or 4% in constant currency, as businesses held off making large tech purchases in the midst of a recession.
"Oracle isn't just competing against SAP, they're competing against companies delaying purchases," said David Rutchik, a consultant with Pace Harmon LLC, which helps companies negotiate deals with Oracle and other large software companies. Mr. Rutchik said that sales of Oracle's software take a long time to complete and that companies budgeted for many of the purchases made earlier this year before the stock market collapsed in October.
But the software maker, based in Redwood Shores, Calif., gave upbeat guidance for the current quarter, reassuring investors that it was well positioned despite the shortfall. For the current quarter, Oracle forecast that its revenue would decline 1% to 4% from a year earlier. The company also forecast that its operating earnings per share for the current quarter would be between 29 cents and 31 cents at the current exchange rate.
Oracle has weathered the recession better than many rivals, in part because about half of its revenue comes from support payments for past sales. Oracle has also gained market share against other software companies over the last year, analysts said.
"When you look at the results in the face of this economic headwind it's pretty impressive," said Brent Thill, an analyst at Citigroup Inc.
The company also said Tuesday it reported its highest margins ever, which it attributed to the ongoing support payments.
Several months ago customers "didn't feel good about spending money," said Oracle President Charles Phillips on a conference call to discuss results Tuesday. "It doesn't feel that way any more."
Oracle executives said they expect to close their $7.4 billion acquisition of Sun Microsystems Inc. in the current quarter. Sun shareholders are scheduled to vote on the sale July 16. Oracle didn't include revenue from Sun in its guidance. It has said it expects Sun to add $1.5 billion to Oracle's operating profit in the first year after the deal closes.
Oracle's shares, which are up about 50% from their March low, closed down 10 cents to $19.87 in 4 p.m. trading on the Nasdaq Stock Market.
Write to Ben Worthen at ben.worthen@wsj.com
Oracle Corp. posted a revenue decline for the first time since 2002, hurt by a strong dollar and companies' continued reluctance to spend on new technology projects.
Oracle, a huge provider of software for businesses, is the first large technology company to report results that include the month of May, and investors were looking for signs that the recession is easing. In April and May, tech companies such as Cisco Systems Inc. and Intel Corp. said orders were leveling off and the worst of the recession might be over.
For the fiscal fourth quarter ended May 31, Oracle's profit dropped 7.2% to $1.89 billion and revenue fell 5.2% to $6.86 billion during what is seasonally one of the company's strongest quarters as it offers discounts to close deals before the end of the fiscal year. It was Oracle's largest earnings drop in three years.
Over the quarter, Oracle, which does about half its business overseas, was hit hard by a strong U.S. dollar. In constant currency, its revenue climbed 4%, and income was up 5%.
Sales of new software dropped 13%, or 4% in constant currency, as businesses held off making large tech purchases in the midst of a recession.
"Oracle isn't just competing against SAP, they're competing against companies delaying purchases," said David Rutchik, a consultant with Pace Harmon LLC, which helps companies negotiate deals with Oracle and other large software companies. Mr. Rutchik said that sales of Oracle's software take a long time to complete and that companies budgeted for many of the purchases made earlier this year before the stock market collapsed in October.
But the software maker, based in Redwood Shores, Calif., gave upbeat guidance for the current quarter, reassuring investors that it was well positioned despite the shortfall. For the current quarter, Oracle forecast that its revenue would decline 1% to 4% from a year earlier. The company also forecast that its operating earnings per share for the current quarter would be between 29 cents and 31 cents at the current exchange rate.
Oracle has weathered the recession better than many rivals, in part because about half of its revenue comes from support payments for past sales. Oracle has also gained market share against other software companies over the last year, analysts said.
"When you look at the results in the face of this economic headwind it's pretty impressive," said Brent Thill, an analyst at Citigroup Inc.
The company also said Tuesday it reported its highest margins ever, which it attributed to the ongoing support payments.
Several months ago customers "didn't feel good about spending money," said Oracle President Charles Phillips on a conference call to discuss results Tuesday. "It doesn't feel that way any more."
Oracle executives said they expect to close their $7.4 billion acquisition of Sun Microsystems Inc. in the current quarter. Sun shareholders are scheduled to vote on the sale July 16. Oracle didn't include revenue from Sun in its guidance. It has said it expects Sun to add $1.5 billion to Oracle's operating profit in the first year after the deal closes.
Oracle's shares, which are up about 50% from their March low, closed down 10 cents to $19.87 in 4 p.m. trading on the Nasdaq Stock Market.
Write to Ben Worthen at ben.worthen@wsj.com
No empty threat
Jun 18th 2009
From The Economist print edition
Credit-default swaps are pitting firms against their own creditors
SIX FLAGS, an American theme-park operator, filed for Chapter 11 bankruptcy protection on June 13th, bringing its long ride to reduce debt obligations to an abrupt halt. The surprise was that bondholders, not the tepid credit markets, stymied the restructuring effort. Bankruptcy codes assume that creditors always attempt to keep solvent firms out of bankruptcy. Six Flags and others are finding that financial innovation has undermined that premise.
Pragmatic lenders who hedged their economic exposure through credit-default swaps (CDSs), a type of insurance against default, can often make higher returns from CDS payouts than from out-of-court restructuring plans. In the case of Six Flags, fingers are pointing at a Fidelity mutual fund for turning down an offer that would have granted unsecured creditors an 85% equity stake. Mike Simonton, an analyst at Fitch, a ratings agency, calculates that uninsured bondholders will receive less than 10% of the equity now that Six Flags has filed for protection.
Some investors take an even more predatory approach. By purchasing a material amount of a firm’s debt in conjunction with a disproportionately large number of CDS contracts, rapacious lenders (mostly hedge funds) can render bankruptcy more attractive than solvency.
Henry Hu of the University of Texas calls this phenomenon the “empty creditor” problem. About two years ago Mr Hu began noticing odd behaviour in bankruptcy proceedings—one bemused courtroom witnessed a junior creditor argue that the valuation placed on a firm was too high. With default rates climbing, he sees such perverse incentives as a looming threat to financial stability. Already the bankruptcies of AbitibiBowater, a paper manufacturer, and General Growth Properties, a property investor, in mid-April have been blamed on bondholders with unusual economic exposures. Some also suspect that CDS contracts played a role in General Motors’ filing earlier this month.
Solutions to the problem are, so far, purely theoretical. One option would be regulation requiring disclosure by investors of all credit-linked positions. There is now almost no disclosure of who owns derivatives on a company’s debt, leaving firms to guess how amenable creditors will be when approached with a restructuring plan. Longer-term solutions rest on an overhaul of the bankruptcy code and debt agreements to award votes and control based on net economic exposure, rather than the nominal amount of debt owned. Supporters of the market point to the value of CDSs in reducing the cost of capital and to plans for a central clearing house that will reduce redundancy and increase transparency. But the reform roller-coaster has not yet come to a halt.
From The Economist print edition
Credit-default swaps are pitting firms against their own creditors
SIX FLAGS, an American theme-park operator, filed for Chapter 11 bankruptcy protection on June 13th, bringing its long ride to reduce debt obligations to an abrupt halt. The surprise was that bondholders, not the tepid credit markets, stymied the restructuring effort. Bankruptcy codes assume that creditors always attempt to keep solvent firms out of bankruptcy. Six Flags and others are finding that financial innovation has undermined that premise.
Pragmatic lenders who hedged their economic exposure through credit-default swaps (CDSs), a type of insurance against default, can often make higher returns from CDS payouts than from out-of-court restructuring plans. In the case of Six Flags, fingers are pointing at a Fidelity mutual fund for turning down an offer that would have granted unsecured creditors an 85% equity stake. Mike Simonton, an analyst at Fitch, a ratings agency, calculates that uninsured bondholders will receive less than 10% of the equity now that Six Flags has filed for protection.
Some investors take an even more predatory approach. By purchasing a material amount of a firm’s debt in conjunction with a disproportionately large number of CDS contracts, rapacious lenders (mostly hedge funds) can render bankruptcy more attractive than solvency.
Henry Hu of the University of Texas calls this phenomenon the “empty creditor” problem. About two years ago Mr Hu began noticing odd behaviour in bankruptcy proceedings—one bemused courtroom witnessed a junior creditor argue that the valuation placed on a firm was too high. With default rates climbing, he sees such perverse incentives as a looming threat to financial stability. Already the bankruptcies of AbitibiBowater, a paper manufacturer, and General Growth Properties, a property investor, in mid-April have been blamed on bondholders with unusual economic exposures. Some also suspect that CDS contracts played a role in General Motors’ filing earlier this month.
Solutions to the problem are, so far, purely theoretical. One option would be regulation requiring disclosure by investors of all credit-linked positions. There is now almost no disclosure of who owns derivatives on a company’s debt, leaving firms to guess how amenable creditors will be when approached with a restructuring plan. Longer-term solutions rest on an overhaul of the bankruptcy code and debt agreements to award votes and control based on net economic exposure, rather than the nominal amount of debt owned. Supporters of the market point to the value of CDSs in reducing the cost of capital and to plans for a central clearing house that will reduce redundancy and increase transparency. But the reform roller-coaster has not yet come to a halt.
Fannie Mae, Freddie Mac First Quarter Delinquencires Rise 19%
By Dawn Kopecki
June 23 (Bloomberg) -- Fannie Mae and Freddie Mac’s
“serious” delinquencies rose 19 percent in the first quarter
as the government sought to retool its anti-foreclosure
programs, a Federal Housing Finance Agency report shows.
The number of borrowers at least 60 days behind on
mortgages owned or guaranteed by the companies rose to 1.1
million from 926,000 in the fourth quarter, FHFA said in a
report on its Web site today. The delinquency rate rose to 3.62
percent, from 3.03 percent the previous quarter.
Fannie Mae and Freddie Mac, seized by FHFA in September
because of their losses, have been pushed by the government to
help more homeowners modify or refinance their loans to more
affordable terms to curb foreclosures. McLean Virginia-based
Freddie Mac and Washington-based Fannie Mae own or guarantee
$5.3 trillion of the $12 trillion in U.S. residential mortgage
debt.
The companies modified 37,328 loans in the first quarter,
up from about 23,777 in the fourth quarter, the report shows.
June 23 (Bloomberg) -- Fannie Mae and Freddie Mac’s
“serious” delinquencies rose 19 percent in the first quarter
as the government sought to retool its anti-foreclosure
programs, a Federal Housing Finance Agency report shows.
The number of borrowers at least 60 days behind on
mortgages owned or guaranteed by the companies rose to 1.1
million from 926,000 in the fourth quarter, FHFA said in a
report on its Web site today. The delinquency rate rose to 3.62
percent, from 3.03 percent the previous quarter.
Fannie Mae and Freddie Mac, seized by FHFA in September
because of their losses, have been pushed by the government to
help more homeowners modify or refinance their loans to more
affordable terms to curb foreclosures. McLean Virginia-based
Freddie Mac and Washington-based Fannie Mae own or guarantee
$5.3 trillion of the $12 trillion in U.S. residential mortgage
debt.
The companies modified 37,328 loans in the first quarter,
up from about 23,777 in the fourth quarter, the report shows.
Good Bet in Market Pullback: Health-Care Shares
By GEOFFREY ROGOW
As sentiment and the stock market increasingly look bearish, look for the recent outperformance in health care to continue.
In the initial run of stocks following the March lows, health-care firms were hardly a leader. Given their defensive posture, many fared much better during the market's plummet and thus didn't receive the snap-back buying that occurred in more cyclical areas. From there, much of the market's gains were led by more rosy economic sentiment globally and a heavy bet against the dollar, both of which fueled big rallies for energy and materials companies, but did little to health care.
Last week, however, health care was the one exception to a sliding market. The Dow Jones Industrial Average lost 3%, and the Standard & Poor's 500 slid 2.7%, but the NYSE Arca Pharmaceutical Index finished in the green, including a 4% gain for the last four days.
And on Monday, even with the S&P 500 closing off an additional 3.1%, the NYSE Arca Pharmaceutical Index fell only 1.8% to 258.33.
"It's been rallying on positive momentum and a rotation back into more defensive areas of the market," said Katie Stockton, chief market technician for MKM Partners. "That will continue through a correction phase likely to benefit large-cap pharma."
In the midst of last week's gains, Ms. Stockton notes the pharmaceutical index confirmed a breakout by moving above its 200-day moving average, though the index hasn't yet broken above its January high of 277.23.
Within the index, which has 15 components, she says leaders are likely to be Sanofi-Aventis and GlaxoSmithKline. Both firms also have recently moved above their 200-day moving averages, while Pfizer hasn't.
Ms. Stockton says it is likely most of the health-care sector will outperform and not just large pharmaceutical companies.
Areas such as health-maintenance organizations, or even biotechnology firms, will outpace the broader market, a sentiment echoed by Christian Bendixen, director of technical research at Bay Crest Partners.
For the broader market, Mr. Bendixen sees a lot of pain ahead, with a fundamental trigger likely to push the S&P 500 back below its March lows by the end of this year or even in early 2010.
"We think once this fall really accelerates, there will be very few places to hide," Mr. Bendixen said. "Our general recommendation is that the only asset classes to be long would be the dollar and Treasurys."
As for stocks, Mr. Bendixen recommends a staunch defensive posture, with health care and large technology firms among the sectors he expects to outperform. But he would shy away from consumer staples, adding "a lot of the individual names in that sector look pretty weak to us."
Write to Geoffrey Rogow at geoffrey.rogow@dowjones.com
As sentiment and the stock market increasingly look bearish, look for the recent outperformance in health care to continue.
In the initial run of stocks following the March lows, health-care firms were hardly a leader. Given their defensive posture, many fared much better during the market's plummet and thus didn't receive the snap-back buying that occurred in more cyclical areas. From there, much of the market's gains were led by more rosy economic sentiment globally and a heavy bet against the dollar, both of which fueled big rallies for energy and materials companies, but did little to health care.
Last week, however, health care was the one exception to a sliding market. The Dow Jones Industrial Average lost 3%, and the Standard & Poor's 500 slid 2.7%, but the NYSE Arca Pharmaceutical Index finished in the green, including a 4% gain for the last four days.
And on Monday, even with the S&P 500 closing off an additional 3.1%, the NYSE Arca Pharmaceutical Index fell only 1.8% to 258.33.
"It's been rallying on positive momentum and a rotation back into more defensive areas of the market," said Katie Stockton, chief market technician for MKM Partners. "That will continue through a correction phase likely to benefit large-cap pharma."
In the midst of last week's gains, Ms. Stockton notes the pharmaceutical index confirmed a breakout by moving above its 200-day moving average, though the index hasn't yet broken above its January high of 277.23.
Within the index, which has 15 components, she says leaders are likely to be Sanofi-Aventis and GlaxoSmithKline. Both firms also have recently moved above their 200-day moving averages, while Pfizer hasn't.
Ms. Stockton says it is likely most of the health-care sector will outperform and not just large pharmaceutical companies.
Areas such as health-maintenance organizations, or even biotechnology firms, will outpace the broader market, a sentiment echoed by Christian Bendixen, director of technical research at Bay Crest Partners.
For the broader market, Mr. Bendixen sees a lot of pain ahead, with a fundamental trigger likely to push the S&P 500 back below its March lows by the end of this year or even in early 2010.
"We think once this fall really accelerates, there will be very few places to hide," Mr. Bendixen said. "Our general recommendation is that the only asset classes to be long would be the dollar and Treasurys."
As for stocks, Mr. Bendixen recommends a staunch defensive posture, with health care and large technology firms among the sectors he expects to outperform. But he would shy away from consumer staples, adding "a lot of the individual names in that sector look pretty weak to us."
Write to Geoffrey Rogow at geoffrey.rogow@dowjones.com
Revamp Would Help Banks Boost Reserves
Provision Seeks to Avert Thin Capital Cushions That Helped to Worsen the Financial Crisis
By MATTHIAS RIEKER
Tucked into the Treasury Department's proposed regulatory overhaul is a push for banks to salt away more money for losses when times are good.
It is a matter dear to bankers and their primary regulators.
For more than a decade, banks have been restricted by accounting standards and the Securities and Exchange Commission from building capital reserves for loan losses that are likely to occur but difficult to predict.
"Banks felt under pressure to keep reserves thin," said Eugene Ludwig, the former comptroller of the currency who now heads consulting firm Promontory Financial Group LLC.
The restrictions worsened the financial crisis for banks. The reserves they set aside during good times didn't cover their losses during the financial crisis, and banks had to scramble for capital.
Last week's proposal by the Obama administration includes a provision that could help avert a repeat of the problems.
"We recommend that the accounting standard setters improve accounting standards for loan-loss provisioning by the end of 2009," the Treasury said in the financial-overhaul plan.
Bankers hold capital reserves mainly for loans to borrowers who are delinquent, or whose default is probable.
That restriction means bank earnings get hit with rising loan-loss provisions in bad times, usually when revenue also declines.
Many bankers disapprove of the current rules. J.P. Morgan Chase & Co. Chairman and Chief Executive James Dimon wrote in the bank's annual report, "I find it absurd that loan-loss reserves tend to be at their lowest point precisely when things are about to get worse."
Bank of America Corp. CEO Kenneth Lewis told CNBC in April that the current rules make "no sense at all."
Mr. Ludwig said bankers "ought to have maximum flexibility to allow for the judgment of management, provided, of course, everything is transparent to the investor."
The International Accounting Standards Board set up an advisory group to review the matter, and the discussion is moving toward allowing banks to reserve for expected losses, similar to the "dynamic-provisioning" rule introduced by the Spanish central bank in 1999.
The method is a statistical probability of default calculated for loans when they are made.
"From the very moment that a loan is granted, and before any impairment on this specific loan appears, there is a positive default probability, no matter how low it might be," Jaime Caruana, then governor of the Bank of Spain, said in a speech in Chicago in 2002.
Dynamic provisioning leads to "sound risk management" and can "moderate cyclical swings," he said.
In the U.S., bank regulators such as the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency would like banks to build big loan-loss reserves.
But the SEC worries that banks can use loan-loss provisions to smooth earnings.
The SEC has tussled twice with regional bank SunTrust Banks Inc. over reserves.
In 1998, when SunTrust wanted to make an acquisition, its loan-loss reserve came under SEC scrutiny.
At the time, the Atlanta bank held a reserve of $666 million, 1.6% of total loans. The SEC forced SunTrust to reduce its reserve by about $100 million because the agency felt the reserve was too high.
In 2004, the SEC took aim at SunTrust again.
The bank's assets had doubled, and its loan-loss reserve stood at almost $1 billion, or just above 1% of loans.
The SEC criticized the company's assumptions in building the reserve, among other things, and SunTrust fired its chief risk officer.
The SEC declined to comment.
In the first quarter this year, SunTrust took $650 million in loan losses, and built its loan-loss reserve to 2.3% of loans, to $2.74 billion as of March 31.
According to the FDIC, banks reserved $194 billion in the first quarter for loan losses, or 2.7% of total loans. In the first quarter of 2006, the overall reserve was $77.7 billion, or 1.1% of loans.
As the real-estate bubble swelled during the next year, the reserve fell slightly.
Soon, banks had to play catch-up.
Not all bankers wanted to build reserves during good times. John Dugan, head of the OCC, said in a speech in March, "We do frequently find ourselves in the position of pressing for higher reserves than the accountants and bankers would like."
Write to Matthias Rieker at matthias.rieker@dowjones.com
By MATTHIAS RIEKER
Tucked into the Treasury Department's proposed regulatory overhaul is a push for banks to salt away more money for losses when times are good.
It is a matter dear to bankers and their primary regulators.
For more than a decade, banks have been restricted by accounting standards and the Securities and Exchange Commission from building capital reserves for loan losses that are likely to occur but difficult to predict.
"Banks felt under pressure to keep reserves thin," said Eugene Ludwig, the former comptroller of the currency who now heads consulting firm Promontory Financial Group LLC.
The restrictions worsened the financial crisis for banks. The reserves they set aside during good times didn't cover their losses during the financial crisis, and banks had to scramble for capital.
Last week's proposal by the Obama administration includes a provision that could help avert a repeat of the problems.
"We recommend that the accounting standard setters improve accounting standards for loan-loss provisioning by the end of 2009," the Treasury said in the financial-overhaul plan.
Bankers hold capital reserves mainly for loans to borrowers who are delinquent, or whose default is probable.
That restriction means bank earnings get hit with rising loan-loss provisions in bad times, usually when revenue also declines.
Many bankers disapprove of the current rules. J.P. Morgan Chase & Co. Chairman and Chief Executive James Dimon wrote in the bank's annual report, "I find it absurd that loan-loss reserves tend to be at their lowest point precisely when things are about to get worse."
Bank of America Corp. CEO Kenneth Lewis told CNBC in April that the current rules make "no sense at all."
Mr. Ludwig said bankers "ought to have maximum flexibility to allow for the judgment of management, provided, of course, everything is transparent to the investor."
The International Accounting Standards Board set up an advisory group to review the matter, and the discussion is moving toward allowing banks to reserve for expected losses, similar to the "dynamic-provisioning" rule introduced by the Spanish central bank in 1999.
The method is a statistical probability of default calculated for loans when they are made.
"From the very moment that a loan is granted, and before any impairment on this specific loan appears, there is a positive default probability, no matter how low it might be," Jaime Caruana, then governor of the Bank of Spain, said in a speech in Chicago in 2002.
Dynamic provisioning leads to "sound risk management" and can "moderate cyclical swings," he said.
In the U.S., bank regulators such as the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency would like banks to build big loan-loss reserves.
But the SEC worries that banks can use loan-loss provisions to smooth earnings.
The SEC has tussled twice with regional bank SunTrust Banks Inc. over reserves.
In 1998, when SunTrust wanted to make an acquisition, its loan-loss reserve came under SEC scrutiny.
At the time, the Atlanta bank held a reserve of $666 million, 1.6% of total loans. The SEC forced SunTrust to reduce its reserve by about $100 million because the agency felt the reserve was too high.
In 2004, the SEC took aim at SunTrust again.
The bank's assets had doubled, and its loan-loss reserve stood at almost $1 billion, or just above 1% of loans.
The SEC criticized the company's assumptions in building the reserve, among other things, and SunTrust fired its chief risk officer.
The SEC declined to comment.
In the first quarter this year, SunTrust took $650 million in loan losses, and built its loan-loss reserve to 2.3% of loans, to $2.74 billion as of March 31.
According to the FDIC, banks reserved $194 billion in the first quarter for loan losses, or 2.7% of total loans. In the first quarter of 2006, the overall reserve was $77.7 billion, or 1.1% of loans.
As the real-estate bubble swelled during the next year, the reserve fell slightly.
Soon, banks had to play catch-up.
Not all bankers wanted to build reserves during good times. John Dugan, head of the OCC, said in a speech in March, "We do frequently find ourselves in the position of pressing for higher reserves than the accountants and bankers would like."
Write to Matthias Rieker at matthias.rieker@dowjones.com
Monday, June 22, 2009
Three Banks Suspend Their TARP Dividends
By DAVID ENRICH and GREGORY ZUCKERMAN
At least three small, cash-strapped banks have stopped paying the U.S. government dividends that they owe because they got $315.4 million in capital infusions under the Troubled Asset Relief Program.
Pacific Capital Bancorp, a Santa Barbara, Calif., lender that got $180.6 million from the Treasury Department in November, has since posted net losses of $49.7 million. Pacific Capital said Monday that it suspended dividend payments on its common and preferred stock as part of a wider effort to save about $8 million per quarter. A bank spokeswoman confirmed that the U.S.'s preferred shares are included in the dividend freeze.
Seacoast Banking Corp. of Florida, of Stuart, Fla., and Midwest Banc Holdings Inc., of Melrose Park, Ill., have also halted their TARP-related dividends, citing the banking industry's turmoil and a desire to fortify their balance sheets.
Treasury spokeswoman Meg Reilly said Monday that "a number of banks" that got taxpayer-funded capital under TARP are no longer paying dividends to the government. "Treasury respects the contractual rights of [TARP recipients] to make decisions about dividend distributions, and that banks are best positioned to decide how to manage their own capital base."
The moves are a sign of the deepening misery for large swaths of the U.S. banking industry, suffering under bad loans and the recession even as large firms such as J.P. Morgan Chase & Co. and Goldman Sachs Group Inc. rebound from the crisis, including by repaying their TARP funds last week.
"Here the government has given the banks money at great terms, but the fact that they can't keep up with it is worrisome," said Michael Shemi, an investor at New York hedge-fund firm Christofferson, Robb & Co. "It tells you of the deep problems of community and regional banks."
Since last October, TARP's Capital Purchase Program has pumped about $200 billion into more than 600 banks across the U.S. The government got preferred shares that generally churn out annual 5% dividends for the first five years, followed by 9% a year until the capital is repaid. The dividends, which are supposed to be paid each quarter, were established to ensure taxpayer funds were being put to good use and weren't handouts.
So far, the Treasury Department has collected about $4.5 billion in dividends from TARP recipients. Pacific Capital, Seacoast and Midwest, which got their TARP money in December, were set to pay the government a total of $16 million a year in dividends. None of the banks mentioned TARP in news releases announcing suspension of the payments, but representatives confirmed Monday that the dividends had been stopped at least temporarily.
Gerard Cassidy, a banking analyst at RBC Capital Markets, said he was surprised that some TARP recipients "already are in such difficult financial situation" that they are no longer making dividend payments. "It goes to show you that the due diligence performed by the Treasury was not sufficient."
Some lawmakers and banking-industry officials have criticized what they view as a lack of transparency and consistency in Treasury's decisions about which banks received aid. Ms. Reilly, the Treasury spokeswoman, said the injections "helped to stabilize the financial system."
Under a provision in the TARP contracts between banks and the U.S. government, a bank usually can defer dividend payments for as long as six quarters, though it eventually will have to cover the entire amount. In a smaller number of contracts in which the Treasury got so-called noncumulative preferred stock, the bank can skip dividend payments without penalty. But if the bank misses six quarterly payments in a row, the Treasury Department can appoint two directors to the bank's board.
George Leis, Pacific Capital's chief executive, said in a statement Monday that hoarding the bank's cash "will improve our flexibility to consider other actions that may need to be taken in order to achieve our targeted capital ratios." The bank, which is wrestling with a spike in loan defaults, plans to resume dividend payments when doing so "would be consistent with our overall financial performance and capital requirements," Mr. Leis said.
The decision to halt the dividends appears to stem partly from federal pressure. In April, the bank entered into a memorandum of understanding with regulators that requires it to boost its capital levels by June 30.
Write to David Enrich at david.enrich@wsj.com and Gregory Zuckerman at gregory.zuckerman@wsj.com
At least three small, cash-strapped banks have stopped paying the U.S. government dividends that they owe because they got $315.4 million in capital infusions under the Troubled Asset Relief Program.
Pacific Capital Bancorp, a Santa Barbara, Calif., lender that got $180.6 million from the Treasury Department in November, has since posted net losses of $49.7 million. Pacific Capital said Monday that it suspended dividend payments on its common and preferred stock as part of a wider effort to save about $8 million per quarter. A bank spokeswoman confirmed that the U.S.'s preferred shares are included in the dividend freeze.
Seacoast Banking Corp. of Florida, of Stuart, Fla., and Midwest Banc Holdings Inc., of Melrose Park, Ill., have also halted their TARP-related dividends, citing the banking industry's turmoil and a desire to fortify their balance sheets.
Treasury spokeswoman Meg Reilly said Monday that "a number of banks" that got taxpayer-funded capital under TARP are no longer paying dividends to the government. "Treasury respects the contractual rights of [TARP recipients] to make decisions about dividend distributions, and that banks are best positioned to decide how to manage their own capital base."
The moves are a sign of the deepening misery for large swaths of the U.S. banking industry, suffering under bad loans and the recession even as large firms such as J.P. Morgan Chase & Co. and Goldman Sachs Group Inc. rebound from the crisis, including by repaying their TARP funds last week.
"Here the government has given the banks money at great terms, but the fact that they can't keep up with it is worrisome," said Michael Shemi, an investor at New York hedge-fund firm Christofferson, Robb & Co. "It tells you of the deep problems of community and regional banks."
Since last October, TARP's Capital Purchase Program has pumped about $200 billion into more than 600 banks across the U.S. The government got preferred shares that generally churn out annual 5% dividends for the first five years, followed by 9% a year until the capital is repaid. The dividends, which are supposed to be paid each quarter, were established to ensure taxpayer funds were being put to good use and weren't handouts.
So far, the Treasury Department has collected about $4.5 billion in dividends from TARP recipients. Pacific Capital, Seacoast and Midwest, which got their TARP money in December, were set to pay the government a total of $16 million a year in dividends. None of the banks mentioned TARP in news releases announcing suspension of the payments, but representatives confirmed Monday that the dividends had been stopped at least temporarily.
Gerard Cassidy, a banking analyst at RBC Capital Markets, said he was surprised that some TARP recipients "already are in such difficult financial situation" that they are no longer making dividend payments. "It goes to show you that the due diligence performed by the Treasury was not sufficient."
Some lawmakers and banking-industry officials have criticized what they view as a lack of transparency and consistency in Treasury's decisions about which banks received aid. Ms. Reilly, the Treasury spokeswoman, said the injections "helped to stabilize the financial system."
Under a provision in the TARP contracts between banks and the U.S. government, a bank usually can defer dividend payments for as long as six quarters, though it eventually will have to cover the entire amount. In a smaller number of contracts in which the Treasury got so-called noncumulative preferred stock, the bank can skip dividend payments without penalty. But if the bank misses six quarterly payments in a row, the Treasury Department can appoint two directors to the bank's board.
George Leis, Pacific Capital's chief executive, said in a statement Monday that hoarding the bank's cash "will improve our flexibility to consider other actions that may need to be taken in order to achieve our targeted capital ratios." The bank, which is wrestling with a spike in loan defaults, plans to resume dividend payments when doing so "would be consistent with our overall financial performance and capital requirements," Mr. Leis said.
The decision to halt the dividends appears to stem partly from federal pressure. In April, the bank entered into a memorandum of understanding with regulators that requires it to boost its capital levels by June 30.
Write to David Enrich at david.enrich@wsj.com and Gregory Zuckerman at gregory.zuckerman@wsj.com
Perils in Indiscriminate Bets on Industrial Resolution
By LIAM DENNING
Beware falling machinery. Industrial-sector stocks have been on even more of a tear than most others since March, jumping about 40%. The concomitant jump in the average 2009 price/earnings multiple for S&P 500 industrials from single digits to about 14 -- while consensus estimates were actually trimmed -- serves as a warning. That doesn't mean avoiding the sector altogether, but it does mean a different investment approach.
Recent exuberance is predicated on perceived economic "green shoots," helped by government stimulus spending. Industrial companies are particularly sensitive to such sentiment. Studying previous sector downturns in the mid-1980s and early 1990s, Scott Davis of Morgan Stanley highlights a pattern of multiples rising early in the downturn followed by renewed pressure as actual earnings fall short of hopes.
This one looks no different. Manufacturing capacity utilization hit a miserable 65% in May. In the last recession, U.S. manufacturing inventories contracted year-on-year for 22 months, according to Sanford Bernstein. In the current downturn, inventories began falling year-on-year in January. Quickly working off that much slack would require an "I"-shaped recovery, never mind "V"-shaped.
Emerson Electric Chief Executive David Farr, for one, doesn't envisage this. Moreover, in a recent Reuters interview, he cautioned that even when the global economy recovers, underlying annual growth for the industry could be half of the high single-digit percentages it has grown used to.
That scenario of slow recovery and lower growth expectations means less pricing power, hitting profit margins. Investors can try picking more resilient subsectors. Government spending on transportation and energy infrastructure will tend to benefit big, diversified companies like General Electric, Siemens and ABB, as well as niche competitors like Vestas Wind Systems. GE, however, remains under the cloud of its finance arm.
More generally, infrastructure projects are long-term earners, not the quick hit to profits investors might dream of. And there is a headwind from other projects being canceled. Mr. Davis estimates about 13% of emerging markets infrastructure projects were canceled in 2008, versus an average since 1993 of 5.9%.
An alternative for investors is to target companies ahead of the game in cutting capacity and costs. This offers a shield to margins while uncertainty remains about demand trends and revenue growth, particularly if raw-material costs remain elevated.
Emerson, for example, will have cut fixed production expenses by 15% in the two years ending in September, reckons Sterne Agee. Along with that, investors can draw comfort from knowing that its chief executive holds no rosy preconceptions about what lies ahead.
Write to Liam Denning at liam.denning@wsj.com
Beware falling machinery. Industrial-sector stocks have been on even more of a tear than most others since March, jumping about 40%. The concomitant jump in the average 2009 price/earnings multiple for S&P 500 industrials from single digits to about 14 -- while consensus estimates were actually trimmed -- serves as a warning. That doesn't mean avoiding the sector altogether, but it does mean a different investment approach.
Recent exuberance is predicated on perceived economic "green shoots," helped by government stimulus spending. Industrial companies are particularly sensitive to such sentiment. Studying previous sector downturns in the mid-1980s and early 1990s, Scott Davis of Morgan Stanley highlights a pattern of multiples rising early in the downturn followed by renewed pressure as actual earnings fall short of hopes.
This one looks no different. Manufacturing capacity utilization hit a miserable 65% in May. In the last recession, U.S. manufacturing inventories contracted year-on-year for 22 months, according to Sanford Bernstein. In the current downturn, inventories began falling year-on-year in January. Quickly working off that much slack would require an "I"-shaped recovery, never mind "V"-shaped.
Emerson Electric Chief Executive David Farr, for one, doesn't envisage this. Moreover, in a recent Reuters interview, he cautioned that even when the global economy recovers, underlying annual growth for the industry could be half of the high single-digit percentages it has grown used to.
That scenario of slow recovery and lower growth expectations means less pricing power, hitting profit margins. Investors can try picking more resilient subsectors. Government spending on transportation and energy infrastructure will tend to benefit big, diversified companies like General Electric, Siemens and ABB, as well as niche competitors like Vestas Wind Systems. GE, however, remains under the cloud of its finance arm.
More generally, infrastructure projects are long-term earners, not the quick hit to profits investors might dream of. And there is a headwind from other projects being canceled. Mr. Davis estimates about 13% of emerging markets infrastructure projects were canceled in 2008, versus an average since 1993 of 5.9%.
An alternative for investors is to target companies ahead of the game in cutting capacity and costs. This offers a shield to margins while uncertainty remains about demand trends and revenue growth, particularly if raw-material costs remain elevated.
Emerson, for example, will have cut fixed production expenses by 15% in the two years ending in September, reckons Sterne Agee. Along with that, investors can draw comfort from knowing that its chief executive holds no rosy preconceptions about what lies ahead.
Write to Liam Denning at liam.denning@wsj.com
Seeking Direction, Market Braces for Data
By MARK GONGLOFF
A new season arrives this week, possibly in more ways than one.
Sunday brought the summer solstice. The workweek brings another slew of economic data with the potential to push the stock market out of its recent rut.
Sales reports on preowned and new homes are due Tuesday and Wednesday, respectively. The Fed wraps up a two-day policy meeting Wednesday, and the Census Bureau releases May durable-goods numbers. Weekly jobless-claims data come Thursday, and the Commerce Department reports Friday on May personal income and spending.
For the past several months, the direction of stocks, commodities and other risky assets has been driven at least partly by whether economic reports have surprised to the upside or downside. William Hester, market analyst at Hussman Funds, keeps an index of economic surprises: a three-month running tally of the number of reports that beat expectations, minus the number of disappointments. That index has roughly tracked the stock market for much of the past year.
The March market rally was born amid a sharp upswing in data beating market expectations. Economists and investors were braced for apocalypse, so merely horrible numbers became pleasant surprises and encouraged risk-taking.
After a few months of that, most of the juice has been wrung from the "less-bad" sponge. Pleasant surprises are rarer as expectations have risen, and the market has lost steam. Downside surprises, like the latest industrial-production and retail-sales numbers, spark selloffs.
"Equity investors need confirmation that nothing worse is coming," says Tobias Levkovich, Citigroup's chief U.S. equity strategist. "If there's a hiccup, then the market reacts badly."
Mr. Levkovich believes the market can still "grind higher" as long as there isn't any backsliding in economic data. More-bearish analysts think stocks are priced for a robust recovery and will need increasingly positive surprises to avoid a collapse, just as an addict needs ever-more-potent fixes.
The Dow Jones Industrial Average is still down 25% from its level before the Lehman Brothers collapse, suggesting the market could handle a subpar recovery.
But a more-significant rally from here will depend, in no small part, on economic data surprising again, and the bar has gotten higher.
Email: tape@wsj.com
A new season arrives this week, possibly in more ways than one.
Sunday brought the summer solstice. The workweek brings another slew of economic data with the potential to push the stock market out of its recent rut.
Sales reports on preowned and new homes are due Tuesday and Wednesday, respectively. The Fed wraps up a two-day policy meeting Wednesday, and the Census Bureau releases May durable-goods numbers. Weekly jobless-claims data come Thursday, and the Commerce Department reports Friday on May personal income and spending.
For the past several months, the direction of stocks, commodities and other risky assets has been driven at least partly by whether economic reports have surprised to the upside or downside. William Hester, market analyst at Hussman Funds, keeps an index of economic surprises: a three-month running tally of the number of reports that beat expectations, minus the number of disappointments. That index has roughly tracked the stock market for much of the past year.
The March market rally was born amid a sharp upswing in data beating market expectations. Economists and investors were braced for apocalypse, so merely horrible numbers became pleasant surprises and encouraged risk-taking.
After a few months of that, most of the juice has been wrung from the "less-bad" sponge. Pleasant surprises are rarer as expectations have risen, and the market has lost steam. Downside surprises, like the latest industrial-production and retail-sales numbers, spark selloffs.
"Equity investors need confirmation that nothing worse is coming," says Tobias Levkovich, Citigroup's chief U.S. equity strategist. "If there's a hiccup, then the market reacts badly."
Mr. Levkovich believes the market can still "grind higher" as long as there isn't any backsliding in economic data. More-bearish analysts think stocks are priced for a robust recovery and will need increasingly positive surprises to avoid a collapse, just as an addict needs ever-more-potent fixes.
The Dow Jones Industrial Average is still down 25% from its level before the Lehman Brothers collapse, suggesting the market could handle a subpar recovery.
But a more-significant rally from here will depend, in no small part, on economic data surprising again, and the bar has gotten higher.
Email: tape@wsj.com
World Bank Warns On Emerging GDP
By JUDITH BURNS
WASHINGTON -- Developing countries' net private capital inflows fell 41% last year and will be cut nearly in half this year, the World Bank said in a report that offers little hope that the countries will provide the spark for the global economic engine.
Meanwhile, European Central Bank Gov. Jean-Claude Trichet said Sunday that the ECB expects the global economy to moderate its slide over the remainder of the year and resume climbing in 2010.
The World Bank estimated in its annual development-finance review that gross domestic product in developing countries will grow just 1.2% this year, well off the 8.1% pace in 2007 and the 5.9% gain in 2008.
The report, issued at a conference in Seoul, projects a 2.9% contraction in global GDP this year, as rich countries contract by 4.5%.
"The crisis of the past two years is having dramatic effects on capital flows to developing countries, and the world appears to be entering an era of lower growth," World Bank Chief Economist Justin Lin said.
The report said net flows of private capital to developing countries fell to $707 billion in 2008 from $1.2 trillion in 2007, and it projects they will fall an additional 48% this year to $363 billion.
"Net private capital flows will be insufficient to meet the external financing needs of many of these [developing] countries, and in view of the intense fiscal pressures triggered by the crisis, the prospects for large increases in aid flows are dim," the report said.
"The bulk of new commitments by international financial institutions will go to middle-income countries in 2009, and workers' remittances to low-income countries are projected to decline by 5%. Such sobering facts reinforce the importance of broad international agreement to mobilize the necessary resources to achieve" United Nations' goals for alleviating world poverty.
On a regional basis, the report offered the following outlook for developing countries:
East Asia and the Pacific: China's fiscal-stimulus efforts should spur a recovery in the region, starting later this year, with regional GDP rising 6.6% in 2010 and 7.8% in 2011.
Europe and Central Asia: GDP is projected to fall 4.7% in 2009, and grow by just 1.6% in 2010.
Latin America and the Caribbean: Regional GDP is seen falling by 2.3% this year, then growing about 2% in 2010.
Middle East and North Africa: While less directly affected by the global credit crunch, growth in the region is expected to be cut roughly in half this year, to 2.1%, before accelerating to 3.8% in 2010 and 4.6% in 2011.
South Asia: GDP is expected to grow by 4.6% this year, followed by 7% next year and 7.8% in 2011.
Sub-Saharan Africa: Sharp declines in remittances and export prices will take a heavy toll on a region that was growing at a 5.7% annual rate in the past three years, with growth slowing to 1% in 2009 and 3.7% in 2010.
In Paris, Mr. Trichet said in an interview with French radio station Europe 1 that the Iran conflict means "there is clearly an additional risk for the international economy," but that Iran isn't the only area of instability in the world. That is all the more reason to proceed quickly with the program put together by the Group of 20 countries in April to deal with the global economic crisis and regulatory reform, he said.
He repeated that the ECB expects the global economy to recover next year. "We expect a slowing in the decline of activity," Mr. Trichet said. "The first quarter was very bad; the following quarters will be less bad, until the end of the year when one can expect pretty much stability in terms of activity," he added. "We should record a resumption of positive activity over the course of next year."
But Mr. Trichet cautioned that governments must gradually address their bloated budget deficits as the economic recovery gathers pace next year.
—A.H. Mooradian in Paris contributed to this article.
Write to Judith Burns at judith.burns@dowjones.com
WASHINGTON -- Developing countries' net private capital inflows fell 41% last year and will be cut nearly in half this year, the World Bank said in a report that offers little hope that the countries will provide the spark for the global economic engine.
Meanwhile, European Central Bank Gov. Jean-Claude Trichet said Sunday that the ECB expects the global economy to moderate its slide over the remainder of the year and resume climbing in 2010.
The World Bank estimated in its annual development-finance review that gross domestic product in developing countries will grow just 1.2% this year, well off the 8.1% pace in 2007 and the 5.9% gain in 2008.
The report, issued at a conference in Seoul, projects a 2.9% contraction in global GDP this year, as rich countries contract by 4.5%.
"The crisis of the past two years is having dramatic effects on capital flows to developing countries, and the world appears to be entering an era of lower growth," World Bank Chief Economist Justin Lin said.
The report said net flows of private capital to developing countries fell to $707 billion in 2008 from $1.2 trillion in 2007, and it projects they will fall an additional 48% this year to $363 billion.
"Net private capital flows will be insufficient to meet the external financing needs of many of these [developing] countries, and in view of the intense fiscal pressures triggered by the crisis, the prospects for large increases in aid flows are dim," the report said.
"The bulk of new commitments by international financial institutions will go to middle-income countries in 2009, and workers' remittances to low-income countries are projected to decline by 5%. Such sobering facts reinforce the importance of broad international agreement to mobilize the necessary resources to achieve" United Nations' goals for alleviating world poverty.
On a regional basis, the report offered the following outlook for developing countries:
East Asia and the Pacific: China's fiscal-stimulus efforts should spur a recovery in the region, starting later this year, with regional GDP rising 6.6% in 2010 and 7.8% in 2011.
Europe and Central Asia: GDP is projected to fall 4.7% in 2009, and grow by just 1.6% in 2010.
Latin America and the Caribbean: Regional GDP is seen falling by 2.3% this year, then growing about 2% in 2010.
Middle East and North Africa: While less directly affected by the global credit crunch, growth in the region is expected to be cut roughly in half this year, to 2.1%, before accelerating to 3.8% in 2010 and 4.6% in 2011.
South Asia: GDP is expected to grow by 4.6% this year, followed by 7% next year and 7.8% in 2011.
Sub-Saharan Africa: Sharp declines in remittances and export prices will take a heavy toll on a region that was growing at a 5.7% annual rate in the past three years, with growth slowing to 1% in 2009 and 3.7% in 2010.
In Paris, Mr. Trichet said in an interview with French radio station Europe 1 that the Iran conflict means "there is clearly an additional risk for the international economy," but that Iran isn't the only area of instability in the world. That is all the more reason to proceed quickly with the program put together by the Group of 20 countries in April to deal with the global economic crisis and regulatory reform, he said.
He repeated that the ECB expects the global economy to recover next year. "We expect a slowing in the decline of activity," Mr. Trichet said. "The first quarter was very bad; the following quarters will be less bad, until the end of the year when one can expect pretty much stability in terms of activity," he added. "We should record a resumption of positive activity over the course of next year."
But Mr. Trichet cautioned that governments must gradually address their bloated budget deficits as the economic recovery gathers pace next year.
—A.H. Mooradian in Paris contributed to this article.
Write to Judith Burns at judith.burns@dowjones.com
A Last Gasp for Asia Aluminum's Creditors
By ANDREW PEAPLE
A bid by Norsk Hydro for Asia Aluminum may ultimately prove too little, too late for the foreign investors who bought some of its riskiest debt.
The case of Asia Aluminum has drawn much interest, highlighting just how poorly offshore debt holders can be treated in the event of a corporate restructuring in China.
Until Norsk Hydro's expression of interest, late last week, the only offer on the table was a management-led buyout that would have left senior debt holders recovering around 20 cents on the dollar. The assorted funds that invested into payment-in-kind, or PIK, notes issued by Asia Aluminum, would have gotten around just one cent.
Unlike traditional bonds, PIK-notes can pay interest only at their maturity. Yields are high but investors have little protection if a company fails.
A tie-up with the world's third largest aluminum supplier would seem to be a welcome development for the PIK-note holders, and a smart strategic move for Asia Aluminum.
But it faces hurdles in China. The priority for officials in Zhaoqing, Asia Aluminum's home province, is job preservation. So the local government is instead supporting the management buyout, that's guaranteed to save 10,000 jobs and keep some familiar faces in charge of a key employer.
And the support of senior debt-holders -- so far silent -- isn't to be taken for granted, given that they have less to lose than the PIK-note holders.
Instead, there may be some in their camp keen to see an end to the saga, preferring the certainty of the management buyout to the still somewhat vaguely defined Norsk bid. The Norwegian company plans to preserve jobs too, but won't be able to submit a detailed bid until June 29, just a day before the deadline.
In the mean time, minds that would need to be open to the deal are either shut already, or closing fast.
Write to Andrew Peaple at andrew.peaple@dowjones.com
A bid by Norsk Hydro for Asia Aluminum may ultimately prove too little, too late for the foreign investors who bought some of its riskiest debt.
The case of Asia Aluminum has drawn much interest, highlighting just how poorly offshore debt holders can be treated in the event of a corporate restructuring in China.
Until Norsk Hydro's expression of interest, late last week, the only offer on the table was a management-led buyout that would have left senior debt holders recovering around 20 cents on the dollar. The assorted funds that invested into payment-in-kind, or PIK, notes issued by Asia Aluminum, would have gotten around just one cent.
Unlike traditional bonds, PIK-notes can pay interest only at their maturity. Yields are high but investors have little protection if a company fails.
A tie-up with the world's third largest aluminum supplier would seem to be a welcome development for the PIK-note holders, and a smart strategic move for Asia Aluminum.
But it faces hurdles in China. The priority for officials in Zhaoqing, Asia Aluminum's home province, is job preservation. So the local government is instead supporting the management buyout, that's guaranteed to save 10,000 jobs and keep some familiar faces in charge of a key employer.
And the support of senior debt-holders -- so far silent -- isn't to be taken for granted, given that they have less to lose than the PIK-note holders.
Instead, there may be some in their camp keen to see an end to the saga, preferring the certainty of the management buyout to the still somewhat vaguely defined Norsk bid. The Norwegian company plans to preserve jobs too, but won't be able to submit a detailed bid until June 29, just a day before the deadline.
In the mean time, minds that would need to be open to the deal are either shut already, or closing fast.
Write to Andrew Peaple at andrew.peaple@dowjones.com
Is the Bull Run Pulling Up Lame?
--trading volumen has been trending dowarward from 7.2 bil shares in March to 5.14 bil shares now
--the number of companies joining the gains have been shrinking
Overextended Rally Seen Ripe for Downturn; Look Out 6547.05, Says Mr. Roth
By E.S. BROWNING
The stock market is stumbling.
After a powerful rally that pushed the Dow Jones Industrial Average ahead by more than 30% in three months through last week, stocks are clearly having trouble extending their gains.
Many analysts see a pullback ahead, and they are debating whether it will be just a temporary annoyance or something bigger and more painful.
Indicators of market health, including trading volume, buying demand and trading by companies and corporate insiders, are beginning to flash yellow or red. People also are beginning to question whether the economic fundamentals are strong enough to justify continued gains.
View Full Image
Christopher Serra
The Dow finished Friday at 8539.73, down 3% for the week. It is at the same levels now as in early May. The Standard & Poor's 500-stock index, which a week ago was up as much as 40% from its March low, ended Friday was at 921.23, still 36% above the low.
"This 40% rally isn't based on a 40% increase in fundamentals," says Michael Farr, president of Washington, D.C., money-management firm Farr, Miller & Washington. "The economy is still declining. Credit isn't coming back. Unemployment is rising and we are seeing a much less robust consumer. I think the market at some point is going to give back a large portion of these gains."
Mr. Farr and others say it is impossible to know whether the market already has topped out, or will edge higher before giving up the ghost. But even many bullish investors see a downturn ahead.
Stocks have surged since early March in part because government stimulus spending has found its way into financial markets and because some investors have moved money out of cash and into stocks.
Other investors may emerge from the sidelines. China Investment Corp., the giant sovereign-wealth fund, is considering potential U.S. investments. Its chairman, Lou Jiwei, has expressed concern that the fund is in danger of missing opportunities as the market rallies, according to people who work with the fund.
While those forces could keep pushing stocks higher for a while, some investors and analysts see signs that the rally's underpinnings already are weakening.
Stocks seem a lot less cheap than before their big gains, and investors are no longer impressed when the economic news is simply less bad than before, says Linda Duessel, market strategist at Federated Investors in Pittsburgh.
She thinks improving corporate-profit reports will help push stocks significantly higher in the summer and fall. But, first, "history would suggest we would get a 5% to 10% correction somewhere," she says.
That's the optimistic view. Pessimists think the damage could be greater, and the real pessimists worry that stocks could fall to new lows by autumn. They say stocks just aren't behaving as they have at the start of past bull markets.
Consider trading volume. Average daily volume for all New York Stock Exchange stocks hit a record of 7.21 billion shares in March, as the rally began and heavy buying sent stocks sharply higher. That slipped to 6.42 billion in April, and so far this month, it is running at 5.14 billion, putting it well below the 2009 average of 6.15 billion a day.
"A new bull market is one when investors are prepared to commit larger and larger amounts of new money to equities," says Paul Desmond, president of Lowry Research in North Palm Beach, Fla. "What we have seen here is a very consistent drop in total volume going back to early April."
Mr. Desmond says his data, going back to the 1930s, don't show any new bull market with such a weak volume trend, which leads him to believe that this rally won't become a lasting bull market.
Other data reinforce that concern. The number of stocks joining in the gains has begun to shrink, which doesn't typically happen this soon in a real bull market. And Mr. Desmond's measure of stock demand, based on the amount of trading volume and price change occurring on stock gains, indicates that demand has been fading, another negative signal.
"Investors are risking smaller and smaller amounts of capital and that is a bad sign," Mr. Desmond says.
Phil Roth of New York brokerage firm Miller Tabak shares many of these concerns, and has other worries as well. New stock issuance hit a record in May, he notes, which has created a lake of supply just as demand is softening. Senior corporate officers, who had been buying for their accounts earlier this year, have become net sellers. Neither trend supports the market.
Mr. Roth says indexes still might gain some ground before topping out, and he wouldn't be surprised to see the Dow hit 9000. But once it starts to fall, he fears, it could sink below the March closing low of 6547.05.
People who recently took money from cash and bought stocks won't want to reverse course unless they get a shock, he says. If they do get a shock, perhaps an indication that the economy's troubles are more lasting than people had hoped, that could produce new selling and new lows. "At some point, investors will be saying, where is the good news?" he says.
Mr. Roth also tracks corporate-bond yields, because falling bond yields make bonds less desirable and can help stocks. While Treasury bond yields overall have been rising this year, the difference, or spread, between corporate yields and Treasurys has been shrinking.
The spread between yields of double-A corporate bonds and Treasury bonds has averaged 1.45 percentage points over the past 30 years, Mr. Roth says. At its worst during the credit crunch last year it was 3.81 points. Recently, it has fallen to 2.78 points, better but still not half way back to average. That means corporate bonds remain more attractive than normal and are competing with stocks for investor money, especially when investors are nervous.
Given the big recent stock gains, investors seem to be waiting for either a fall in price or a considerable brightening in the economic outlook before they put a lot more money into the market.
"We could see a little bit more upside and then some very frustrating, choppy trading in the summer, setting up for a traditional October low," warns John Schlitz, chief technical strategist at Instinet in New York.
Write to E.S. Browning at jim.browning@wsj.com
--the number of companies joining the gains have been shrinking
Overextended Rally Seen Ripe for Downturn; Look Out 6547.05, Says Mr. Roth
By E.S. BROWNING
The stock market is stumbling.
After a powerful rally that pushed the Dow Jones Industrial Average ahead by more than 30% in three months through last week, stocks are clearly having trouble extending their gains.
Many analysts see a pullback ahead, and they are debating whether it will be just a temporary annoyance or something bigger and more painful.
Indicators of market health, including trading volume, buying demand and trading by companies and corporate insiders, are beginning to flash yellow or red. People also are beginning to question whether the economic fundamentals are strong enough to justify continued gains.
View Full Image
Christopher Serra
The Dow finished Friday at 8539.73, down 3% for the week. It is at the same levels now as in early May. The Standard & Poor's 500-stock index, which a week ago was up as much as 40% from its March low, ended Friday was at 921.23, still 36% above the low.
"This 40% rally isn't based on a 40% increase in fundamentals," says Michael Farr, president of Washington, D.C., money-management firm Farr, Miller & Washington. "The economy is still declining. Credit isn't coming back. Unemployment is rising and we are seeing a much less robust consumer. I think the market at some point is going to give back a large portion of these gains."
Mr. Farr and others say it is impossible to know whether the market already has topped out, or will edge higher before giving up the ghost. But even many bullish investors see a downturn ahead.
Stocks have surged since early March in part because government stimulus spending has found its way into financial markets and because some investors have moved money out of cash and into stocks.
Other investors may emerge from the sidelines. China Investment Corp., the giant sovereign-wealth fund, is considering potential U.S. investments. Its chairman, Lou Jiwei, has expressed concern that the fund is in danger of missing opportunities as the market rallies, according to people who work with the fund.
While those forces could keep pushing stocks higher for a while, some investors and analysts see signs that the rally's underpinnings already are weakening.
Stocks seem a lot less cheap than before their big gains, and investors are no longer impressed when the economic news is simply less bad than before, says Linda Duessel, market strategist at Federated Investors in Pittsburgh.
She thinks improving corporate-profit reports will help push stocks significantly higher in the summer and fall. But, first, "history would suggest we would get a 5% to 10% correction somewhere," she says.
That's the optimistic view. Pessimists think the damage could be greater, and the real pessimists worry that stocks could fall to new lows by autumn. They say stocks just aren't behaving as they have at the start of past bull markets.
Consider trading volume. Average daily volume for all New York Stock Exchange stocks hit a record of 7.21 billion shares in March, as the rally began and heavy buying sent stocks sharply higher. That slipped to 6.42 billion in April, and so far this month, it is running at 5.14 billion, putting it well below the 2009 average of 6.15 billion a day.
"A new bull market is one when investors are prepared to commit larger and larger amounts of new money to equities," says Paul Desmond, president of Lowry Research in North Palm Beach, Fla. "What we have seen here is a very consistent drop in total volume going back to early April."
Mr. Desmond says his data, going back to the 1930s, don't show any new bull market with such a weak volume trend, which leads him to believe that this rally won't become a lasting bull market.
Other data reinforce that concern. The number of stocks joining in the gains has begun to shrink, which doesn't typically happen this soon in a real bull market. And Mr. Desmond's measure of stock demand, based on the amount of trading volume and price change occurring on stock gains, indicates that demand has been fading, another negative signal.
"Investors are risking smaller and smaller amounts of capital and that is a bad sign," Mr. Desmond says.
Phil Roth of New York brokerage firm Miller Tabak shares many of these concerns, and has other worries as well. New stock issuance hit a record in May, he notes, which has created a lake of supply just as demand is softening. Senior corporate officers, who had been buying for their accounts earlier this year, have become net sellers. Neither trend supports the market.
Mr. Roth says indexes still might gain some ground before topping out, and he wouldn't be surprised to see the Dow hit 9000. But once it starts to fall, he fears, it could sink below the March closing low of 6547.05.
People who recently took money from cash and bought stocks won't want to reverse course unless they get a shock, he says. If they do get a shock, perhaps an indication that the economy's troubles are more lasting than people had hoped, that could produce new selling and new lows. "At some point, investors will be saying, where is the good news?" he says.
Mr. Roth also tracks corporate-bond yields, because falling bond yields make bonds less desirable and can help stocks. While Treasury bond yields overall have been rising this year, the difference, or spread, between corporate yields and Treasurys has been shrinking.
The spread between yields of double-A corporate bonds and Treasury bonds has averaged 1.45 percentage points over the past 30 years, Mr. Roth says. At its worst during the credit crunch last year it was 3.81 points. Recently, it has fallen to 2.78 points, better but still not half way back to average. That means corporate bonds remain more attractive than normal and are competing with stocks for investor money, especially when investors are nervous.
Given the big recent stock gains, investors seem to be waiting for either a fall in price or a considerable brightening in the economic outlook before they put a lot more money into the market.
"We could see a little bit more upside and then some very frustrating, choppy trading in the summer, setting up for a traditional October low," warns John Schlitz, chief technical strategist at Instinet in New York.
Write to E.S. Browning at jim.browning@wsj.com
Saturday, June 20, 2009
MARKET LED BY MULTIPLE
David Rosenberg
We heard at the market lows in March that the stock market had sunk to Armageddon levels. We have often thought about that because we can certainly understand that at the 2.0% lows on the 10-year Treasury note yield, we had gone to a place we had not seen on over five decades. Also, with Baa spreads north of 600bps, we could see that corporate bonds had moved to levels not seen in seven decades as well.
But this notion that we had moved to Armageddon lows in equities does not seem to hold water. After all, the forward P/E multiple on the S&P 500 at the lows was 11.7x. That was not a multi-decade low or some massive standard-deviation figure — we were actually lower than that at the October 1990 lows when the multiple was 10.5x and frankly, coming off the 1987 collapse, the forward P/E had compressed to 9.8x. As it now stands, the multiple is back very close to where it was at the October 2007 market high when the multiple had expanded to 15.0x. The range on the forward P/E over the last quarter-century is between 9.8x and 21.8x (excluding the tech bubble), so at 14.5x currently, it is hardly the case that this market can be viewed as a bargain.
On a trailing earnings basis, the P/E multiple has actually widened, from 17.0x at the lows to 23.3x currently, a huge multiple expansion. At this stage of the 2003 recovery, the multiple hardly expanded at all, earnings were driving the rebound; coming off the October 1990 lows, the multiple expansion four months into the rally was closer to 2x; and the powerful surge in the post-1982 recovery saw a 3x multiple point expansion at this juncture — not 6x!
As an aside, when the U.S. government is now putting its fingers into more than one-third of the economy (health, finance, autos, energy, housing), one would expect that the fair-value multiple in the future will be lower than it has been — given the implications for productivity and the potential non-inflationary growth potential.
We heard at the market lows in March that the stock market had sunk to Armageddon levels. We have often thought about that because we can certainly understand that at the 2.0% lows on the 10-year Treasury note yield, we had gone to a place we had not seen on over five decades. Also, with Baa spreads north of 600bps, we could see that corporate bonds had moved to levels not seen in seven decades as well.
But this notion that we had moved to Armageddon lows in equities does not seem to hold water. After all, the forward P/E multiple on the S&P 500 at the lows was 11.7x. That was not a multi-decade low or some massive standard-deviation figure — we were actually lower than that at the October 1990 lows when the multiple was 10.5x and frankly, coming off the 1987 collapse, the forward P/E had compressed to 9.8x. As it now stands, the multiple is back very close to where it was at the October 2007 market high when the multiple had expanded to 15.0x. The range on the forward P/E over the last quarter-century is between 9.8x and 21.8x (excluding the tech bubble), so at 14.5x currently, it is hardly the case that this market can be viewed as a bargain.
On a trailing earnings basis, the P/E multiple has actually widened, from 17.0x at the lows to 23.3x currently, a huge multiple expansion. At this stage of the 2003 recovery, the multiple hardly expanded at all, earnings were driving the rebound; coming off the October 1990 lows, the multiple expansion four months into the rally was closer to 2x; and the powerful surge in the post-1982 recovery saw a 3x multiple point expansion at this juncture — not 6x!
As an aside, when the U.S. government is now putting its fingers into more than one-third of the economy (health, finance, autos, energy, housing), one would expect that the fair-value multiple in the future will be lower than it has been — given the implications for productivity and the potential non-inflationary growth potential.
Investors Shouldn't Gorge on Natural Gas
By LIAM DENNING
Junk food appeals to our primal instincts: It is a cheap way of loading up on calories.
Right now, natural gas is the energy world's junk food. Burning a barrel of oil releases about 5.8 million British thermal units of energy. In theory, therefore, the price of oil, measured in barrels, should be roughly six times that of natural gas, which is priced per million BTUs.
Since 1994, the average has been 8.6 times. Today, with spot natural gas costing about $4 per million BTUs, it is almost 18 times.
Investors with faith in mean-reverting markets smell an opportunity to sell oil and buy natural gas.
Yet the ratio itself has become increasingly irrelevant as the underlying fuels have decoupled in terms of use since the 1970s.
Transportation accounts for 70% of U.S. oil consumption now, while most natural gas is used for heating, power generation and industrial processes. That largely rules out switching between them in response to short-term price signals.
Oil trades globally, whereas natural gas, mostly shipped in pipelines, is characterized by regional markets. This matters because, as Francisco Blanch, head of global commodity research at Banc of America-Merrill Lynch, says, U.S. natural gas "is the mirror image of oil."
While resource nationalism in foreign countries limited investment in response to high oil prices, high natural-gas prices earlier this decade sparked a drilling boom at home.
Compounding this, the U.S. can now import as much as 19% of its needs as liquefied natural gas shipped in from further afield. The global recession has squeezed the spread in natural-gas prices between the U.S. and traditionally more expensive overseas markets, increasing the chances of LNG cargoes targeting America. LNG production facilities have low variable operating costs, meaning natural-gas prices would have to collapse even further before they were mothballed.
Amazingly, though, U.S. natural-gas output actually rose in the first quarter, while demand fell 5%. This is despite the number of rigs operating falling by more than half in the past year, suggesting production per rig has been increasing.
Exploration and production companies also have shown skill at navigating the downturn. The sector's investment case is predicated on growth, and capital expenditure has outpaced operating cash flow for several years.
E&P companies believe, with some cause, time is on their side, given political trends favoring lower-carbon-emitting fossil fuels like natural gas. The recent stock-market rally has allowed several overleveraged companies to recapitalize.
Futures markets also lend support. The December 2010 contract commands $7.25 per million BTUs, implying an oil/natural-gas ratio of 10.8 times. This reflects hopes of natural-gas demand reviving with the economy next year and allows drillers to lock in higher prices. This week, EnCana, North America's largest producer, announced it had sold 35% of its expected 2010 output at an average price of $6.21 per million BTUs.
Then there is the high oil/natural-gas ratio. Many natural-gas producers also produce oil. Credit Suisse analyst Jonathan Wolff points out that the extra cash flow provided by the rebound in crude prices offers further relief for some E&P companies.
So natural-gas producers live to drill another day -- meaning pressure on prices is unlikely to lift.
For now, exuberant markets allow producers to keep selling output forward, as well as raising equity to repair balance sheets and keep spending. Come fall, if already high natural-gas inventories have risen further, such forgiveness will be in short supply. The oil/natural-gas ratio may well have come in, but more likely because of faltering crude prices.
Write to Liam Denning at liam.denning@wsj.com
Junk food appeals to our primal instincts: It is a cheap way of loading up on calories.
Right now, natural gas is the energy world's junk food. Burning a barrel of oil releases about 5.8 million British thermal units of energy. In theory, therefore, the price of oil, measured in barrels, should be roughly six times that of natural gas, which is priced per million BTUs.
Since 1994, the average has been 8.6 times. Today, with spot natural gas costing about $4 per million BTUs, it is almost 18 times.
Investors with faith in mean-reverting markets smell an opportunity to sell oil and buy natural gas.
Yet the ratio itself has become increasingly irrelevant as the underlying fuels have decoupled in terms of use since the 1970s.
Transportation accounts for 70% of U.S. oil consumption now, while most natural gas is used for heating, power generation and industrial processes. That largely rules out switching between them in response to short-term price signals.
Oil trades globally, whereas natural gas, mostly shipped in pipelines, is characterized by regional markets. This matters because, as Francisco Blanch, head of global commodity research at Banc of America-Merrill Lynch, says, U.S. natural gas "is the mirror image of oil."
While resource nationalism in foreign countries limited investment in response to high oil prices, high natural-gas prices earlier this decade sparked a drilling boom at home.
Compounding this, the U.S. can now import as much as 19% of its needs as liquefied natural gas shipped in from further afield. The global recession has squeezed the spread in natural-gas prices between the U.S. and traditionally more expensive overseas markets, increasing the chances of LNG cargoes targeting America. LNG production facilities have low variable operating costs, meaning natural-gas prices would have to collapse even further before they were mothballed.
Amazingly, though, U.S. natural-gas output actually rose in the first quarter, while demand fell 5%. This is despite the number of rigs operating falling by more than half in the past year, suggesting production per rig has been increasing.
Exploration and production companies also have shown skill at navigating the downturn. The sector's investment case is predicated on growth, and capital expenditure has outpaced operating cash flow for several years.
E&P companies believe, with some cause, time is on their side, given political trends favoring lower-carbon-emitting fossil fuels like natural gas. The recent stock-market rally has allowed several overleveraged companies to recapitalize.
Futures markets also lend support. The December 2010 contract commands $7.25 per million BTUs, implying an oil/natural-gas ratio of 10.8 times. This reflects hopes of natural-gas demand reviving with the economy next year and allows drillers to lock in higher prices. This week, EnCana, North America's largest producer, announced it had sold 35% of its expected 2010 output at an average price of $6.21 per million BTUs.
Then there is the high oil/natural-gas ratio. Many natural-gas producers also produce oil. Credit Suisse analyst Jonathan Wolff points out that the extra cash flow provided by the rebound in crude prices offers further relief for some E&P companies.
So natural-gas producers live to drill another day -- meaning pressure on prices is unlikely to lift.
For now, exuberant markets allow producers to keep selling output forward, as well as raising equity to repair balance sheets and keep spending. Come fall, if already high natural-gas inventories have risen further, such forgiveness will be in short supply. The oil/natural-gas ratio may well have come in, but more likely because of faltering crude prices.
Write to Liam Denning at liam.denning@wsj.com
Friday, June 19, 2009
Global Forecast Update: After the Deepest Recession, the Weakest Recovery
By Joachim Fels London
Bottom-fishing: In our previous Global Forecast Snapshots two months ago, we argued that a bottom for the global economy was in sight. Our global team's read of the data released since then suggests that the bottom now seems to be in place and has thus arrived a bit earlier than expected. Following three quarters of outright contraction - during which global GDP dropped by about 3% from its peak in 2Q08 to the (likely) trough in 1Q09 - we estimate that the global economy returned to positive, though very subdued, growth in the current quarter. While we had still expected global economic activity to contract slightly in 2Q09 two months ago, we currently see global GDP tracking at a positive 2% seasonally adjusted annualised pace this quarter. Thus, the massive global policy stimulus applied in response to the credit crisis has successfully short-circuited the vertiginous downward spiral of global demand, output and trade witnessed during late 2008 and early 2009. As we see it, the stimulus helped to spark the recovery in risky asset markets and vaporised deflation fears, thus supporting economic activity.
Asia leads, the US and Europe lag: Remarkably, global GDP growth has turned positive even though the US and euro area economies, which together account for more than 40% of global GDP, are still sinking. We only expect these two laggards to start growing gradually later this year. The turnaround in global activity almost entirely reflects a bounce in Asia in recent months, led by China and now becoming visible too in Japan, India and elsewhere in the region. Consequently, our local teams in Asia have upgraded their 2009/10 GDP forecasts for most countries over the past two months. With commodity prices having risen on the back the rebound in Asia and ample global liquidity, our Latin American economists have also just revised up their forecasts significantly, especially for Brazil (see This Week in Latin America, June 16, 2009). By contrast, our 2009 euro area GDP forecast has been downgraded again, reflecting the even-worse-than-expected outcome for 1Q and a bad start to 2Q. Likewise, most of our recent revisions for 2009 GDP in Central and Eastern Europe have still been on the downside.
After the deepest recession, the weakest recovery: While global bottoming is now happening, we continue to believe that hopes for a V-shaped global recovery will be disappointed. Consumers are likely to be cautious in the face of rising unemployment (labour markets lag), companies will hold back on capex in the face of high excess capacities, and construction activity is unlikely to rebound sharply with house prices still falling in many countries. Thus, final demand growth is likely to be sluggish in the foreseeable future, despite the strong support from fiscal and monetary policies. In our baseline forecast, we see global GDP expanding at quarterly annualised rates of only 2-3% between now and the end of 2010, unusually low for early recovery phases. This would take full-year 2010 GDP growth to 2.9% (from -1.6% this year), still well below the 4.7% average annual growth rate in the five years preceding the crisis. Given the downdraft in activity over the last few quarters, our forecasts imply that it would take until the middle of 2010 for global GDP to return to its previous peak level reached in 2Q08. In the G-10 advanced economies, which were hit harder than most EM economies by the credit crisis and which we expect to show a very anaemic recovery, only about half of the total GDP peak-to-trough loss of some 4.5% during the recession will have been recouped by the end of 2010.
Could we be wrong? Yes, easily, because of the unprecedented combination of a hugely negative shock to the financial system, whose effects are still lingering, and a massive monetary and fiscal response. All available models are estimated using data on ‘normal' business cycles and policy reactions, and are thus of little help in gauging what lies ahead. That's why we continue to emphasise the risks on both sides of our base case and regularly construct a bull and a bear case that should each have a ‘reasonable' outside chance (of about 20% each) of occurring. In our bear case, we assume that policy finds very little further traction in the advanced economies in the remainder of this year, risky assets tumble again and EM recoveries falter as global risk-aversion returns. Global GDP would shrink by 3% this year (against -1.6% in our base case) and grow by only 1.4% next year (base case: 2.9%). Conversely, in the bull case, policy finds strong traction, asset markets rally further and the financial sector recovers quickly, translating into a V-shaped recovery that produces close to 5% GDP growth in 2010.
No early monetary policy reversal: With the economic recovery likely to be tepid, the financial sector remaining fragile and inflation expected to remain subdued, we expect the major central banks to keep rates at the currently abnormally low levels for the remainder of this year and, in most cases, well into next year. On our baseline forecasts, the Bank of England and the Bank of Canada will be first out of the blocks, probably in 1Q10, followed by the ECB and the Swedish Riksbank in 2Q. Our US team has pencilled in the first Fed rate hike for around the middle of next year, and our Japan team sees the Bank of Japan starting to tighten only towards the end of 2010. As we have argued elsewhere (see "QExit", The Global Monetary Analyst, May 20, 2009), most central banks are likely to unwind quantitative easing very gradually and with simultaneous increases in official rates. With much of the announced quantitative easing still to come over the next several months, and policy rates likely to remain at their very low levels until 2010, we believe that global excess liquidity is likely to rise further and remain plentiful for the foreseeable future.
For our complete forecasts, please see Global Forecast Snapshots, June 18, 2009.
Bottom-fishing: In our previous Global Forecast Snapshots two months ago, we argued that a bottom for the global economy was in sight. Our global team's read of the data released since then suggests that the bottom now seems to be in place and has thus arrived a bit earlier than expected. Following three quarters of outright contraction - during which global GDP dropped by about 3% from its peak in 2Q08 to the (likely) trough in 1Q09 - we estimate that the global economy returned to positive, though very subdued, growth in the current quarter. While we had still expected global economic activity to contract slightly in 2Q09 two months ago, we currently see global GDP tracking at a positive 2% seasonally adjusted annualised pace this quarter. Thus, the massive global policy stimulus applied in response to the credit crisis has successfully short-circuited the vertiginous downward spiral of global demand, output and trade witnessed during late 2008 and early 2009. As we see it, the stimulus helped to spark the recovery in risky asset markets and vaporised deflation fears, thus supporting economic activity.
Asia leads, the US and Europe lag: Remarkably, global GDP growth has turned positive even though the US and euro area economies, which together account for more than 40% of global GDP, are still sinking. We only expect these two laggards to start growing gradually later this year. The turnaround in global activity almost entirely reflects a bounce in Asia in recent months, led by China and now becoming visible too in Japan, India and elsewhere in the region. Consequently, our local teams in Asia have upgraded their 2009/10 GDP forecasts for most countries over the past two months. With commodity prices having risen on the back the rebound in Asia and ample global liquidity, our Latin American economists have also just revised up their forecasts significantly, especially for Brazil (see This Week in Latin America, June 16, 2009). By contrast, our 2009 euro area GDP forecast has been downgraded again, reflecting the even-worse-than-expected outcome for 1Q and a bad start to 2Q. Likewise, most of our recent revisions for 2009 GDP in Central and Eastern Europe have still been on the downside.
After the deepest recession, the weakest recovery: While global bottoming is now happening, we continue to believe that hopes for a V-shaped global recovery will be disappointed. Consumers are likely to be cautious in the face of rising unemployment (labour markets lag), companies will hold back on capex in the face of high excess capacities, and construction activity is unlikely to rebound sharply with house prices still falling in many countries. Thus, final demand growth is likely to be sluggish in the foreseeable future, despite the strong support from fiscal and monetary policies. In our baseline forecast, we see global GDP expanding at quarterly annualised rates of only 2-3% between now and the end of 2010, unusually low for early recovery phases. This would take full-year 2010 GDP growth to 2.9% (from -1.6% this year), still well below the 4.7% average annual growth rate in the five years preceding the crisis. Given the downdraft in activity over the last few quarters, our forecasts imply that it would take until the middle of 2010 for global GDP to return to its previous peak level reached in 2Q08. In the G-10 advanced economies, which were hit harder than most EM economies by the credit crisis and which we expect to show a very anaemic recovery, only about half of the total GDP peak-to-trough loss of some 4.5% during the recession will have been recouped by the end of 2010.
Could we be wrong? Yes, easily, because of the unprecedented combination of a hugely negative shock to the financial system, whose effects are still lingering, and a massive monetary and fiscal response. All available models are estimated using data on ‘normal' business cycles and policy reactions, and are thus of little help in gauging what lies ahead. That's why we continue to emphasise the risks on both sides of our base case and regularly construct a bull and a bear case that should each have a ‘reasonable' outside chance (of about 20% each) of occurring. In our bear case, we assume that policy finds very little further traction in the advanced economies in the remainder of this year, risky assets tumble again and EM recoveries falter as global risk-aversion returns. Global GDP would shrink by 3% this year (against -1.6% in our base case) and grow by only 1.4% next year (base case: 2.9%). Conversely, in the bull case, policy finds strong traction, asset markets rally further and the financial sector recovers quickly, translating into a V-shaped recovery that produces close to 5% GDP growth in 2010.
No early monetary policy reversal: With the economic recovery likely to be tepid, the financial sector remaining fragile and inflation expected to remain subdued, we expect the major central banks to keep rates at the currently abnormally low levels for the remainder of this year and, in most cases, well into next year. On our baseline forecasts, the Bank of England and the Bank of Canada will be first out of the blocks, probably in 1Q10, followed by the ECB and the Swedish Riksbank in 2Q. Our US team has pencilled in the first Fed rate hike for around the middle of next year, and our Japan team sees the Bank of Japan starting to tighten only towards the end of 2010. As we have argued elsewhere (see "QExit", The Global Monetary Analyst, May 20, 2009), most central banks are likely to unwind quantitative easing very gradually and with simultaneous increases in official rates. With much of the announced quantitative easing still to come over the next several months, and policy rates likely to remain at their very low levels until 2010, we believe that global excess liquidity is likely to rise further and remain plentiful for the foreseeable future.
For our complete forecasts, please see Global Forecast Snapshots, June 18, 2009.
Out of the Shadows
Paul Krugman
Yes, the plan would plug some big holes in regulation. But as described, it wouldn’t end the skewed incentives that made the current crisis inevitable.
Let’s start with the good news.
Our current system of financial regulation dates back to a time when everything that functioned as a bank looked like a bank. As long as you regulated big marble buildings with rows of tellers, you pretty much had things nailed down.
But today you don’t have to look like a bank to be a bank. As Tim Geithner, the Treasury secretary, put it in a widely cited speech last summer, banking is anything that involves financing “long-term risky and relatively illiquid assets” with “very short-term liabilities.” Cases in point: Bear Stearns and Lehman, both of which financed large investments in risky securities primarily with short-term borrowing.
And as Mr. Geithner pointed out, by 2007 more than half of America’s banking, in this sense, was being handled by a “parallel financial system” — others call it “shadow banking” — of largely unregulated institutions. These non-bank banks, he ruefully noted, were “vulnerable to a classic type of run, but without the protections such as deposit insurance that the banking system has in place to reduce such risks.”
When Lehman fell, we learned just how vulnerable shadow banking was: a global run on the system brought the world economy to its knees.
One thing financial reform must do, then, is bring non-bank banking out of the shadows.
The Obama plan does this by giving the Federal Reserve the power to regulate any large financial institution it deems “systemically important” — that is, able to create havoc if it fails — whether or not that institution is a traditional bank. Such institutions would be required to hold relatively large amounts of capital to cover possible losses, relatively large amounts of cash to cover possible demands from creditors, and so on.
And the government would have the authority to seize such institutions if they appear insolvent — the kind of power that the Federal Deposit Insurance Corporation already has with regard to traditional banks, but that has been lacking with regard to institutions like Lehman or A.I.G.
Good stuff. But what about the broader problem of financial excess?
President Obama’s speech outlining the financial plan described the underlying problem very well. Wall Street developed a “culture of irresponsibility,” the president said. Lenders didn’t hold on to their loans, but instead sold them off to be repackaged into securities, which in turn were sold to investors who didn’t understand what they were buying. “Meanwhile,” he said, “executive compensation — unmoored from long-term performance or even reality — rewarded recklessness rather than responsibility.”
Unfortunately, the plan as released doesn’t live up to the diagnosis.
True, the proposed new Consumer Financial Protection Agency would help control abusive lending. And the proposal that lenders be required to hold on to 5 percent of their loans, rather than selling everything off to be repackaged, would provide some incentive to lend responsibly.
But 5 percent isn’t enough to deter much risky lending, given the huge rewards to financial executives who book short-term profits. So what should be done about those rewards?
Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen.
Furthermore, the plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.
In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators.
I’m aware of the political realities: getting financial reform through Congress won’t be easy. And even as it stands the Obama plan would be a lot better than nothing.
But to live up to its own analysis, the Obama administration needs to come down harder on the rating agencies and, even more important, get much more specific about reforming the way bankers are paid.
Yes, the plan would plug some big holes in regulation. But as described, it wouldn’t end the skewed incentives that made the current crisis inevitable.
Let’s start with the good news.
Our current system of financial regulation dates back to a time when everything that functioned as a bank looked like a bank. As long as you regulated big marble buildings with rows of tellers, you pretty much had things nailed down.
But today you don’t have to look like a bank to be a bank. As Tim Geithner, the Treasury secretary, put it in a widely cited speech last summer, banking is anything that involves financing “long-term risky and relatively illiquid assets” with “very short-term liabilities.” Cases in point: Bear Stearns and Lehman, both of which financed large investments in risky securities primarily with short-term borrowing.
And as Mr. Geithner pointed out, by 2007 more than half of America’s banking, in this sense, was being handled by a “parallel financial system” — others call it “shadow banking” — of largely unregulated institutions. These non-bank banks, he ruefully noted, were “vulnerable to a classic type of run, but without the protections such as deposit insurance that the banking system has in place to reduce such risks.”
When Lehman fell, we learned just how vulnerable shadow banking was: a global run on the system brought the world economy to its knees.
One thing financial reform must do, then, is bring non-bank banking out of the shadows.
The Obama plan does this by giving the Federal Reserve the power to regulate any large financial institution it deems “systemically important” — that is, able to create havoc if it fails — whether or not that institution is a traditional bank. Such institutions would be required to hold relatively large amounts of capital to cover possible losses, relatively large amounts of cash to cover possible demands from creditors, and so on.
And the government would have the authority to seize such institutions if they appear insolvent — the kind of power that the Federal Deposit Insurance Corporation already has with regard to traditional banks, but that has been lacking with regard to institutions like Lehman or A.I.G.
Good stuff. But what about the broader problem of financial excess?
President Obama’s speech outlining the financial plan described the underlying problem very well. Wall Street developed a “culture of irresponsibility,” the president said. Lenders didn’t hold on to their loans, but instead sold them off to be repackaged into securities, which in turn were sold to investors who didn’t understand what they were buying. “Meanwhile,” he said, “executive compensation — unmoored from long-term performance or even reality — rewarded recklessness rather than responsibility.”
Unfortunately, the plan as released doesn’t live up to the diagnosis.
True, the proposed new Consumer Financial Protection Agency would help control abusive lending. And the proposal that lenders be required to hold on to 5 percent of their loans, rather than selling everything off to be repackaged, would provide some incentive to lend responsibly.
But 5 percent isn’t enough to deter much risky lending, given the huge rewards to financial executives who book short-term profits. So what should be done about those rewards?
Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen.
Furthermore, the plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.
In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators.
I’m aware of the political realities: getting financial reform through Congress won’t be easy. And even as it stands the Obama plan would be a lot better than nothing.
But to live up to its own analysis, the Obama administration needs to come down harder on the rating agencies and, even more important, get much more specific about reforming the way bankers are paid.
Consumers Drive Bulk of BlackBerry Growth
By SARA SILVER
Consumer demand for high-end cellphones boosted the fortunes of BlackBerry maker Research In Motion Ltd., helping offset a slump in business spending and increasing competition.
The handset maker posted a 33% jump in quarterly profit as it added 3.8 million new BlackBerry subscribers. But the company's revenue and customer growth was slightly below levels reached during the holiday quarter.
RIM Co-Chief Executive Jim Balsillie said 80% of subscriber additions in the latest quarter came from consumers and small businesses, rather than corporate users. That's up from 60% a year ago. RIM has introduced a slew of new devices, from flip-phones to touchscreens, and lowered prices on older models to lure consumers.
The company posted sales of $3.42 billion for its fiscal first quarter, which ended May 30, up 53% from the year-ago period but down from $3.46 billion in the fourth quarter. Profit rose to $643 million, or $1.12 a share, compared with $483 million, or 84 cents a share, a year ago.
Some analysts downplayed the significance of RIM's sequentially flat shipments and sales. "A seasonal downtick of 1% in revenue following the Christmas holiday seems like a small thing to me," said Michael Urlocker, telecom analyst at GMP Securities.
RIM is fending off increasing competition from Apple Inc., which this month unveiled a new iPhone, and cut prices on older models to as little as $99. Also this month, Palm Inc. released its Pre smart phone, which has a touch screen and a slide-out keyboard.
On a conference call Thursday, Mr. Balsillie said the company isn't worried about the competition. "We don't really, sort of, fret those kinds of things," he said.
The smart-phone market continues to expand, despite a contraction in the global cellphone market. One reason is new software applications like social-networking and sales-force tools that make the devices more versatile for consumers and businesses. These applications are helping to offset the declines from companies laying off employees or shutting down.
More broadly, despite the recession, the spread of messaging as a means of communication is driving ordinary consumers to seek out BlackBerry devices, once seen as the workhorse of Wall Street analysts and executive jet-setters.
"I need a BlackBerry," says De-Adedra Anderson, who uses a desktop computer and cellphone to coordinate education for 170 students at a Harlem elementary school. "There are so many times I get emails or text messages... and I won't see it."
While developed nations have been the primary buyers of smart phones, the devices are increasingly being used in developing nations as substitutes for home computers and Internet connections. One hot market for BlackBerry is Indonesia, where carriers now offer the device on a prepaid basis for consumers who don't want contracts.
As RIM has become one of the biggest handset vendors it "is experiencing the same seasonality hitting the overall cellphone market," said Bonny Joy, wireless analyst at Strategy Analytics.
—Stuart Weinberg contributed to this article.
Consumer demand for high-end cellphones boosted the fortunes of BlackBerry maker Research In Motion Ltd., helping offset a slump in business spending and increasing competition.
The handset maker posted a 33% jump in quarterly profit as it added 3.8 million new BlackBerry subscribers. But the company's revenue and customer growth was slightly below levels reached during the holiday quarter.
RIM Co-Chief Executive Jim Balsillie said 80% of subscriber additions in the latest quarter came from consumers and small businesses, rather than corporate users. That's up from 60% a year ago. RIM has introduced a slew of new devices, from flip-phones to touchscreens, and lowered prices on older models to lure consumers.
The company posted sales of $3.42 billion for its fiscal first quarter, which ended May 30, up 53% from the year-ago period but down from $3.46 billion in the fourth quarter. Profit rose to $643 million, or $1.12 a share, compared with $483 million, or 84 cents a share, a year ago.
Some analysts downplayed the significance of RIM's sequentially flat shipments and sales. "A seasonal downtick of 1% in revenue following the Christmas holiday seems like a small thing to me," said Michael Urlocker, telecom analyst at GMP Securities.
RIM is fending off increasing competition from Apple Inc., which this month unveiled a new iPhone, and cut prices on older models to as little as $99. Also this month, Palm Inc. released its Pre smart phone, which has a touch screen and a slide-out keyboard.
On a conference call Thursday, Mr. Balsillie said the company isn't worried about the competition. "We don't really, sort of, fret those kinds of things," he said.
The smart-phone market continues to expand, despite a contraction in the global cellphone market. One reason is new software applications like social-networking and sales-force tools that make the devices more versatile for consumers and businesses. These applications are helping to offset the declines from companies laying off employees or shutting down.
More broadly, despite the recession, the spread of messaging as a means of communication is driving ordinary consumers to seek out BlackBerry devices, once seen as the workhorse of Wall Street analysts and executive jet-setters.
"I need a BlackBerry," says De-Adedra Anderson, who uses a desktop computer and cellphone to coordinate education for 170 students at a Harlem elementary school. "There are so many times I get emails or text messages... and I won't see it."
While developed nations have been the primary buyers of smart phones, the devices are increasingly being used in developing nations as substitutes for home computers and Internet connections. One hot market for BlackBerry is Indonesia, where carriers now offer the device on a prepaid basis for consumers who don't want contracts.
As RIM has become one of the biggest handset vendors it "is experiencing the same seasonality hitting the overall cellphone market," said Bonny Joy, wireless analyst at Strategy Analytics.
—Stuart Weinberg contributed to this article.
Corporate Lenders Get Hit
Financial-Oversight Bill Snags Loan Arms of Harley, Target; Girding for Battle
By DAVID ENRICH and ROBIN SIDEL
Target Corp., Harley-Davidson Inc., Pitney Bowes Inc. and dozens of other companies that aren't banks but pitch loans and other financial products are being squeezed by the Obama administration's financial-overhaul plan.
One proposal being pushed by the White House takes aim at industrial loan companies, which are allowed under their state-issued charters to collect federally insured deposits, offer credit cards, make loans and process financial transactions without facing as much scrutiny as traditional banks regulated by the U.S. government.
President Barack Obama wants companies with ILC charters to register as bank-holding companies with the Federal Reserve. That would put them in the same regulatory category as Bank of America Corp. and J.P. Morgan Chase & Co., subjecting the non-banks to much greater government oversight.
If that happens, most companies with ILC charters likely would close them down, potentially shutting off another source of credit for consumers, industry experts predict. That's because the companies might not be able to satisfy the Fed's capital and other requirements, and thus would be ineligible to become bank-holding companies, or they would balk at heavier regulation.
As of last month, there were 45 ILCs with combined assets of $232.3 billion, according to the Federal Deposit Insurance Corp. That is equivalent in size to the 11th-largest U.S. bank, or slightly smaller than regional bank U.S. Bancorp.
Though relatively small players in the financial system, ILCs provide a wide variety of products and services to businesses and consumers. The offerings range from financing purchases of Harley motorcycles to loans that cover corporate medical payments to insurers. Eliminating or sharply curtailing those operations could make it harder or costlier for customers to get credit.
In its "white paper" outlining the reform package, the administration said the existence of ILCs and other non-bank charters have allowed certain institutions "to obtain access to the federal safety net," namely through insured deposits, while avoiding oversight by the Fed. The administration argues that in order for a regulator to be sufficiently powerful, it has to be able to see all the risks, and thus oversee all companies that provide financial services.
ILCs provide a wide variety of products and services, from financing purchases of Harley motorcycles to loans for corporate medical payments
That's setting the stage for a showdown on Capitol Hill. Some lawmakers and banking groups are vowing to fight the ILC provision, which they see as an overzealous attempt to create a level regulatory playing field at the expense of companies that didn't play major roles in the financial crisis.
"There is not a single ILC that contributed to the crisis," said Sen. Robert Bennett, a Utah Republican, at a hearing Thursday with Treasury Secretary Timothy Geithner. "You're going to wipe them out as a source of credit, take them out of the marketplace where they're providing niche credit for people that don't otherwise get it."
Mr. Geithner responded that the change is meant to eliminate "gaps and loopholes" in financial regulation. But he said the administration is open to negotiating the plank with lawmakers. "We're going to have to work to try to persuade you of the merits of these proposals and take your concerns into consideration," Mr. Geithner said.
The brewing fight over the ILC proposal, tucked into a single paragraph in an 88-page document released Wednesday, is an early indicator of the intense scrutiny that the Obama administration's reform plan will encounter as lawmakers and industry groups pore over its details. In addition to policy disputes, lawmakers are looking to protect local industries. Utah, for example, is home to most of the nation's ILCs, although California, Nevada and other states also are popular destinations for the charters. Only a handful of states offer ILC charters, and for those that do, they can be a source of tax revenue.
Treasury Secretary Timothy Geithner gives his testimony about regulatory reform before the Senate Banking Committee Thursday.
Howard Headlee, president of the Utah Bankers Association, called the Obama administration proposal "extremely misguided" and said it would force many ILCs to shut down. But he said he's optimistic that lawmakers will kill the provision. "I'm confident that congressmen will see how foolish it is to be destroying sources of credit in this economy."
If the provision becomes law, the implications could be far-reaching. A diverse array of companies -- including Target, Pitney Bowes, UnitedHealth Group Inc., WellPoint Inc. and CMS Energy Corp. -- have Utah-based financing arms with ILC charters.
The companies use the charters to provide financial services that complement their main businesses and can be a source of profits. For example, Target, the Minneapolis-based retailer, uses its Target Bank subsidiary to extend credit to shoppers. UnitedHealth's OptumHealth Bank Inc. administers health-savings accounts and offers loans to cover medical payments, as does WellPoint's Arcus Financial Bank. EnerBank USA, a unit of Jackson, Mich.-based CMS Energy, finances home-improvement and energy loans nationwide. Pitney Bowes Bank Inc. allows businesses to prepay or borrow funds for postage costs.
Most of those companies said they were studying the administration's proposal and that it would be premature to comment. Pitney Bowes, which established its ILC in 1998, said it "will work to educate Congress about their role in providing credit for commercial activity -- something that is even more important during the current recession. We think it is important that these services continue."
The obscure banking charters, originally created in the early 1900s to provide loans to industrial workers, have been a sporadic source of controversy for years.
Federal Reserve officials, including ex-Chairman Alan Greenspan, have warned about the perils of allowing traditional commercial businesses to have banking operations. One concern is that the banking portion of the business could be at risk if, say, the retailing side went under. There are also competitive issues if giant companies use their existing customer base to crowd out traditional banks.
In 2006, ILCs were thrust into an especially bright spotlight after Wal-Mart Stores Inc. applied for a charter to process credit-card transactions. Banks waged an aggressive lobbying campaign to derail the retailing behemoth's application, arguing that it was laying the groundwork for a foray into retail banking.
Amid the mounting furor, the FDIC imposed a moratorium on new applications for ILC charters, to allow Congress time to debate whether to change the law. Wal-Mart withdrew its application.
In May 2007, the U.S. House passed a bill that would subject ILCs to greater federal oversight and bar the charters from being granted to nonfinancial firms. The bill died in the Senate.
—Damian Paletta and Ann Zimmerman contributed to this article.
Write to David Enrich at david.enrich@wsj.com and Robin Sidel at robin.sidel@wsj.com
By DAVID ENRICH and ROBIN SIDEL
Target Corp., Harley-Davidson Inc., Pitney Bowes Inc. and dozens of other companies that aren't banks but pitch loans and other financial products are being squeezed by the Obama administration's financial-overhaul plan.
One proposal being pushed by the White House takes aim at industrial loan companies, which are allowed under their state-issued charters to collect federally insured deposits, offer credit cards, make loans and process financial transactions without facing as much scrutiny as traditional banks regulated by the U.S. government.
President Barack Obama wants companies with ILC charters to register as bank-holding companies with the Federal Reserve. That would put them in the same regulatory category as Bank of America Corp. and J.P. Morgan Chase & Co., subjecting the non-banks to much greater government oversight.
If that happens, most companies with ILC charters likely would close them down, potentially shutting off another source of credit for consumers, industry experts predict. That's because the companies might not be able to satisfy the Fed's capital and other requirements, and thus would be ineligible to become bank-holding companies, or they would balk at heavier regulation.
As of last month, there were 45 ILCs with combined assets of $232.3 billion, according to the Federal Deposit Insurance Corp. That is equivalent in size to the 11th-largest U.S. bank, or slightly smaller than regional bank U.S. Bancorp.
Though relatively small players in the financial system, ILCs provide a wide variety of products and services to businesses and consumers. The offerings range from financing purchases of Harley motorcycles to loans that cover corporate medical payments to insurers. Eliminating or sharply curtailing those operations could make it harder or costlier for customers to get credit.
In its "white paper" outlining the reform package, the administration said the existence of ILCs and other non-bank charters have allowed certain institutions "to obtain access to the federal safety net," namely through insured deposits, while avoiding oversight by the Fed. The administration argues that in order for a regulator to be sufficiently powerful, it has to be able to see all the risks, and thus oversee all companies that provide financial services.
ILCs provide a wide variety of products and services, from financing purchases of Harley motorcycles to loans for corporate medical payments
That's setting the stage for a showdown on Capitol Hill. Some lawmakers and banking groups are vowing to fight the ILC provision, which they see as an overzealous attempt to create a level regulatory playing field at the expense of companies that didn't play major roles in the financial crisis.
"There is not a single ILC that contributed to the crisis," said Sen. Robert Bennett, a Utah Republican, at a hearing Thursday with Treasury Secretary Timothy Geithner. "You're going to wipe them out as a source of credit, take them out of the marketplace where they're providing niche credit for people that don't otherwise get it."
Mr. Geithner responded that the change is meant to eliminate "gaps and loopholes" in financial regulation. But he said the administration is open to negotiating the plank with lawmakers. "We're going to have to work to try to persuade you of the merits of these proposals and take your concerns into consideration," Mr. Geithner said.
The brewing fight over the ILC proposal, tucked into a single paragraph in an 88-page document released Wednesday, is an early indicator of the intense scrutiny that the Obama administration's reform plan will encounter as lawmakers and industry groups pore over its details. In addition to policy disputes, lawmakers are looking to protect local industries. Utah, for example, is home to most of the nation's ILCs, although California, Nevada and other states also are popular destinations for the charters. Only a handful of states offer ILC charters, and for those that do, they can be a source of tax revenue.
Treasury Secretary Timothy Geithner gives his testimony about regulatory reform before the Senate Banking Committee Thursday.
Howard Headlee, president of the Utah Bankers Association, called the Obama administration proposal "extremely misguided" and said it would force many ILCs to shut down. But he said he's optimistic that lawmakers will kill the provision. "I'm confident that congressmen will see how foolish it is to be destroying sources of credit in this economy."
If the provision becomes law, the implications could be far-reaching. A diverse array of companies -- including Target, Pitney Bowes, UnitedHealth Group Inc., WellPoint Inc. and CMS Energy Corp. -- have Utah-based financing arms with ILC charters.
The companies use the charters to provide financial services that complement their main businesses and can be a source of profits. For example, Target, the Minneapolis-based retailer, uses its Target Bank subsidiary to extend credit to shoppers. UnitedHealth's OptumHealth Bank Inc. administers health-savings accounts and offers loans to cover medical payments, as does WellPoint's Arcus Financial Bank. EnerBank USA, a unit of Jackson, Mich.-based CMS Energy, finances home-improvement and energy loans nationwide. Pitney Bowes Bank Inc. allows businesses to prepay or borrow funds for postage costs.
Most of those companies said they were studying the administration's proposal and that it would be premature to comment. Pitney Bowes, which established its ILC in 1998, said it "will work to educate Congress about their role in providing credit for commercial activity -- something that is even more important during the current recession. We think it is important that these services continue."
The obscure banking charters, originally created in the early 1900s to provide loans to industrial workers, have been a sporadic source of controversy for years.
Federal Reserve officials, including ex-Chairman Alan Greenspan, have warned about the perils of allowing traditional commercial businesses to have banking operations. One concern is that the banking portion of the business could be at risk if, say, the retailing side went under. There are also competitive issues if giant companies use their existing customer base to crowd out traditional banks.
In 2006, ILCs were thrust into an especially bright spotlight after Wal-Mart Stores Inc. applied for a charter to process credit-card transactions. Banks waged an aggressive lobbying campaign to derail the retailing behemoth's application, arguing that it was laying the groundwork for a foray into retail banking.
Amid the mounting furor, the FDIC imposed a moratorium on new applications for ILC charters, to allow Congress time to debate whether to change the law. Wal-Mart withdrew its application.
In May 2007, the U.S. House passed a bill that would subject ILCs to greater federal oversight and bar the charters from being granted to nonfinancial firms. The bill died in the Senate.
—Damian Paletta and Ann Zimmerman contributed to this article.
Write to David Enrich at david.enrich@wsj.com and Robin Sidel at robin.sidel@wsj.com
China Ready to Place Bets on Hedge Funds
By JENNY STRASBURG in New York and RICK CAREW in Hong Kong
China Investment Corp. is poised to invest $500 million in a Blackstone Group hedge-fund unit as part of a broad effort to put cash to work while global markets are rallying but remain below earlier peaks.
A hefty injection from China would be welcome news for hedge funds, eager to raise fresh capital after brutal markets and an exodus of investors hurt the industry. It also would offer another sign that some big money is stepping off the sidelines as markets stabilize world-wide.
Companies and investors are watching to see if sovereign-wealth funds will once again channel significant money into new deals, after several were burned by high-profile U.S. investments during the financial crisis. Though Middle East funds have ratcheted up spending lately, some remain hobbled by woes at home.
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STEPPING UP: Lou Jiwei of China Investment Corp. sees opportunity.
CIC is considering opening its checkbook to a handful of hedge funds, a move that comes as CIC Chairman Lou Jiwei is concerned his fund may miss opportunities near the bottom of the market, according to people who work closely with the Chinese fund. That is a reversal in attitude from December, when Mr. Lou said he didn't have "the courage" to invest in the developed world's financial institutions because "we don't know what trouble they are in."
A spokeswoman for CIC and a spokesman for Blackstone declined to comment.
Set up in 2007 and capitalized by Beijing, CIC is one of the world's largest sovereign-wealth funds, controlling some $200 billion. The fund already knows Blackstone well, and has suffered some from the relationship. CIC invested $3 billion for a nearly 10% stake in Blackstone just before it went public in 2007, an investment that brought it ridicule in China when the private-equity firm's shares fell. Since Blackstone's IPO two years ago this coming Monday, Blackstone shares have dropped about 64%, leaving CIC with a loss of about $1.9 billion.
Still, CIC managers later struck a deal with Blackstone allowing the fund to increase its stake to 12.5%, signaling confidence in the firm's prospects. And committing capital to Blackstone's hedge-fund unit is a bet more on its expertise than its stock.
That Blackstone division has about $26 billion in investments doled out to hedge funds on behalf of Blackstone clients. One of the world's largest so-called fund-of-fund managers, Blackstone commands access to some of the biggest funds.
It isn't clear how much CIC might allocate to hedge funds. In the past, CIC officials have said they plan to farm out up to $80 billion to asset managers, with private-equity firms and hedge funds likely to get a chunk of that capital.
Prominent hedge funds have been talking to CIC for months. Eric Mindich of Eton Park Capital Management and John Paulson of Paulson & Co. are among hedge-fund bosses who have met with CIC representatives, among other Asian investors, in recent months, according to people familiar with the matter. Wall Street insiders see those hedge funds as on a relatively short list of managers more likely than peers to get CIC money, though such decisions could take months.
Investment staffers at the Chinese fund also have sought the hedge-fund managers' view of the credit crisis and global markets in general.
Last year, James Simons, head of big hedge-fund firm Renaissance Technologies, talked with CIC about selling a stake in Renaissance but didn't do a deal, people familiar with the matter said.
Spokesmen for the hedge funds declined to comment.
The China fund's plans don't necessarily mark a trend toward more global investments by sovereign-wealth funds. Temasek Holdings Pte. Ltd., Singapore's state-owned investment firm, this year has moved to focus more on Asia investments, selling off stakes in foreign banks at big losses.
In the Middle East, there has been continued deal activity. In March, Abu Dhabi investors snapped up a 9.1% stake in Daimler AG. And earlier this month, the government-backed investment company of Qatar said it is considering a deal to invest in Porsche Automobil Holding SE. The buying comes as the region's fortunes have started to turn around, thanks in large measure to climbing oil prices.
But some big Mideast players remain reined in. Kuwait, hobbled by political infighting and a banking crisis, withdrew from a planned joint venture with Dow Chemical Co. late last year, blaming the global financial crisis. And Dubai, another U.A.E. emirate, is still reeling from its property-market bust and lately has refrained from big international deal-making.
CIC has been ramping up activity. CIC in late 2007 put $5.6 billion in Morgan Stanley convertible securities whose value later plunged. But earlier this month, CIC plowed an additional $1.2 billion into Morgan Stanley. On Tuesday, CIC struck its first known property deal, agreeing to commit 200 million Australian dollars (US$158.9 million) to a financing facility for Goodman Group, Australia's largest industrial-property trust.
Elsewhere, CIC put $3.2 billion toward a $4 billion fund managed by J.C. Flowers & Co. to hunt for opportunities among financial institutions.
—Chip Cummins in Dubai contributed to this article.
China Investment Corp. is poised to invest $500 million in a Blackstone Group hedge-fund unit as part of a broad effort to put cash to work while global markets are rallying but remain below earlier peaks.
A hefty injection from China would be welcome news for hedge funds, eager to raise fresh capital after brutal markets and an exodus of investors hurt the industry. It also would offer another sign that some big money is stepping off the sidelines as markets stabilize world-wide.
Companies and investors are watching to see if sovereign-wealth funds will once again channel significant money into new deals, after several were burned by high-profile U.S. investments during the financial crisis. Though Middle East funds have ratcheted up spending lately, some remain hobbled by woes at home.
View Full Image
EyePress News/Newscom
STEPPING UP: Lou Jiwei of China Investment Corp. sees opportunity.
CIC is considering opening its checkbook to a handful of hedge funds, a move that comes as CIC Chairman Lou Jiwei is concerned his fund may miss opportunities near the bottom of the market, according to people who work closely with the Chinese fund. That is a reversal in attitude from December, when Mr. Lou said he didn't have "the courage" to invest in the developed world's financial institutions because "we don't know what trouble they are in."
A spokeswoman for CIC and a spokesman for Blackstone declined to comment.
Set up in 2007 and capitalized by Beijing, CIC is one of the world's largest sovereign-wealth funds, controlling some $200 billion. The fund already knows Blackstone well, and has suffered some from the relationship. CIC invested $3 billion for a nearly 10% stake in Blackstone just before it went public in 2007, an investment that brought it ridicule in China when the private-equity firm's shares fell. Since Blackstone's IPO two years ago this coming Monday, Blackstone shares have dropped about 64%, leaving CIC with a loss of about $1.9 billion.
Still, CIC managers later struck a deal with Blackstone allowing the fund to increase its stake to 12.5%, signaling confidence in the firm's prospects. And committing capital to Blackstone's hedge-fund unit is a bet more on its expertise than its stock.
That Blackstone division has about $26 billion in investments doled out to hedge funds on behalf of Blackstone clients. One of the world's largest so-called fund-of-fund managers, Blackstone commands access to some of the biggest funds.
It isn't clear how much CIC might allocate to hedge funds. In the past, CIC officials have said they plan to farm out up to $80 billion to asset managers, with private-equity firms and hedge funds likely to get a chunk of that capital.
Prominent hedge funds have been talking to CIC for months. Eric Mindich of Eton Park Capital Management and John Paulson of Paulson & Co. are among hedge-fund bosses who have met with CIC representatives, among other Asian investors, in recent months, according to people familiar with the matter. Wall Street insiders see those hedge funds as on a relatively short list of managers more likely than peers to get CIC money, though such decisions could take months.
Investment staffers at the Chinese fund also have sought the hedge-fund managers' view of the credit crisis and global markets in general.
Last year, James Simons, head of big hedge-fund firm Renaissance Technologies, talked with CIC about selling a stake in Renaissance but didn't do a deal, people familiar with the matter said.
Spokesmen for the hedge funds declined to comment.
The China fund's plans don't necessarily mark a trend toward more global investments by sovereign-wealth funds. Temasek Holdings Pte. Ltd., Singapore's state-owned investment firm, this year has moved to focus more on Asia investments, selling off stakes in foreign banks at big losses.
In the Middle East, there has been continued deal activity. In March, Abu Dhabi investors snapped up a 9.1% stake in Daimler AG. And earlier this month, the government-backed investment company of Qatar said it is considering a deal to invest in Porsche Automobil Holding SE. The buying comes as the region's fortunes have started to turn around, thanks in large measure to climbing oil prices.
But some big Mideast players remain reined in. Kuwait, hobbled by political infighting and a banking crisis, withdrew from a planned joint venture with Dow Chemical Co. late last year, blaming the global financial crisis. And Dubai, another U.A.E. emirate, is still reeling from its property-market bust and lately has refrained from big international deal-making.
CIC has been ramping up activity. CIC in late 2007 put $5.6 billion in Morgan Stanley convertible securities whose value later plunged. But earlier this month, CIC plowed an additional $1.2 billion into Morgan Stanley. On Tuesday, CIC struck its first known property deal, agreeing to commit 200 million Australian dollars (US$158.9 million) to a financing facility for Goodman Group, Australia's largest industrial-property trust.
Elsewhere, CIC put $3.2 billion toward a $4 billion fund managed by J.C. Flowers & Co. to hunt for opportunities among financial institutions.
—Chip Cummins in Dubai contributed to this article.
Thursday, June 18, 2009
Investors Early to the Dolans' Garden Party at Cablevision
By MARTIN PEERS
Talk about short memories.
Just a year ago Cablevision Systems shares were afflicted with the "Dolan discount," so named for the family that controls the company. Today, with its stock up 47% since March, the New York cable operator enjoys a "Dolan premium" to its peers.
Both Comcast and Time Warner Cable trade on multiples of enterprise value to earnings before interest, taxes, depreciation and amortization of about five times, compared with Cablevision's 6.7.
The premium is hard to justify. Yes, Cablevision deserves credit for its operational results, including the 151% jump in free cash flow in the first quarter -- better than either of its bigger peers. It has signed up a higher portion of its customers for higher-end digital cable, phone and Internet services.
The flip side, of course, is that Cablevision has less opportunity for growth. And much of the credit for the cable performance should accrue to Chief Operating Officer Tom Rutledge, whose employment contract is up in December. While he may very well re-sign, it isn't a slam dunk.
And offsetting the sterling cash generation is Cablevision's history of ill-conceived acquisitions (Newsday, the Wiz, Clearview Cinemas) and other investments (Fuse, a music TV network), which worried investors last summer.
Then there is its gradual expansion into live entertainment, spearheaded by the Madison Square Garden and Radio City acquisitions in the 1990s.
Live entertainment is inherently volatile.
The Garden's profitability has bounced around like a Knicks basketball, from $4.5 million in operating income in 2003 to $117 million a year later, down to $53 million in 2005 and then to a loss in 2006. A year later profit returned.
Cablevision hasn't helped matters by moving Fuse into the Garden since the start of 2008. A restatement of 2007 divisional results for the transfer reduced MSG's operating income 17%.
The premium rating has widened since the company said it was exploring a spinoff of the Garden.
Given Cablevision's history of announcing possible restructurings that aren't consummated, though, the applause is a little premature.
CEO Jim Dolan feels Cablevision doesn't get credit for the Garden's asset value. He is probably right.
But the considerable value of the Knicks and Rangers, in particular, comes mainly in their status as trophy assets -- best realized in a sale, not a spinoff. And Cablevision has ruled out selling.
The real benefit for Cablevision shareholders would come if, as is speculated, Mr. Dolan moves with MSG. Only then, by creating the real prospect of a sale of the valuable cable business, would Cablevision deserve a premium.
Write to Martin Peers at martin.peers@wsj.com
Talk about short memories.
Just a year ago Cablevision Systems shares were afflicted with the "Dolan discount," so named for the family that controls the company. Today, with its stock up 47% since March, the New York cable operator enjoys a "Dolan premium" to its peers.
Both Comcast and Time Warner Cable trade on multiples of enterprise value to earnings before interest, taxes, depreciation and amortization of about five times, compared with Cablevision's 6.7.
The premium is hard to justify. Yes, Cablevision deserves credit for its operational results, including the 151% jump in free cash flow in the first quarter -- better than either of its bigger peers. It has signed up a higher portion of its customers for higher-end digital cable, phone and Internet services.
The flip side, of course, is that Cablevision has less opportunity for growth. And much of the credit for the cable performance should accrue to Chief Operating Officer Tom Rutledge, whose employment contract is up in December. While he may very well re-sign, it isn't a slam dunk.
And offsetting the sterling cash generation is Cablevision's history of ill-conceived acquisitions (Newsday, the Wiz, Clearview Cinemas) and other investments (Fuse, a music TV network), which worried investors last summer.
Then there is its gradual expansion into live entertainment, spearheaded by the Madison Square Garden and Radio City acquisitions in the 1990s.
Live entertainment is inherently volatile.
The Garden's profitability has bounced around like a Knicks basketball, from $4.5 million in operating income in 2003 to $117 million a year later, down to $53 million in 2005 and then to a loss in 2006. A year later profit returned.
Cablevision hasn't helped matters by moving Fuse into the Garden since the start of 2008. A restatement of 2007 divisional results for the transfer reduced MSG's operating income 17%.
The premium rating has widened since the company said it was exploring a spinoff of the Garden.
Given Cablevision's history of announcing possible restructurings that aren't consummated, though, the applause is a little premature.
CEO Jim Dolan feels Cablevision doesn't get credit for the Garden's asset value. He is probably right.
But the considerable value of the Knicks and Rangers, in particular, comes mainly in their status as trophy assets -- best realized in a sale, not a spinoff. And Cablevision has ruled out selling.
The real benefit for Cablevision shareholders would come if, as is speculated, Mr. Dolan moves with MSG. Only then, by creating the real prospect of a sale of the valuable cable business, would Cablevision deserve a premium.
Write to Martin Peers at martin.peers@wsj.com
Doublethink Spells Trouble for Credit
By RICHARD BARLEY
Credit markets are suffering from cognitive dissonance -- the uncomfortable feeling of holding two contradictory beliefs simultaneously.
On one hand, investors fear fabled green shoots will turn out to be killer weeds.
On the other, they see a "wall of money," much of it from retail investors, driving up prices, and don't want to be left behind.
Perception is at odds with position -- a recipe for renewed market instability.
This is clear from recent investor surveys. European credit investors held record long positions in May, while also seeing high inflows, according to Citigroup and J.P. Morgan. Yet 60% of investors plan to reduce exposure or hold steady -- even as more than half expect to have more money to manage, according to J.P. Morgan.
Investor holdings are still concentrated in safer sectors such as telecommunications and utilities, and cash positions are way above average.
But new issuance is coming increasingly from companies with low credit ratings and in cyclical sectors like steel. Wide spreads on such offerings are attracting less risk-averse investors.
Meanwhile, conservative investors are missing out on the market rally.
Further evidence of this dissonance comes from credit default swaps, where spreads have widened even as cash bond spreads have continued tightening and demand for new issues has remained strong.
The CDX North American Investment Grade index has widened by 0.15 percentage point from its lows, while Merrill Lynch's corporate master bond index has tightened about 0.20 percentage point over the same period.
How will this conflict be resolved?
Much depends on retail investors, who are still piling into the market.
In the U.K., sterling corporate bond funds have been the top destination for retail investors every month since November, according to the Investment Management Association.
In the U.S., bond-fund inflows year-to-date added 6.5% to assets under management, TrimTabs Investment Research data show.
Allocations of new euro bond issues to retail buyers have jumped to 20% this year from 3% last year, according to Société Générale.
They are even leaping back into the bank capital market: Standard Chartered's $1.5 billion Tier 1 deal, sold largely to Asian retail investors, was six times oversubscribed this week.
What isn't clear is whether retail investors are a leading or a lagging indicator: Does their arrival signal the rally has further to run, or is it time for the smart money to exit?
For now, the technical factor of inflows trumps fundamental concerns over credit quality and the economy. But that could change if corporate bond yields rise -- either due to another shock or because underlying government bond yields climb -- and retail investors suffer.
At that point the balance of power could change, and bearish institutional investors may find their fears justified.
Write to Richard Barley at richard.barley@dowjones.com
Credit markets are suffering from cognitive dissonance -- the uncomfortable feeling of holding two contradictory beliefs simultaneously.
On one hand, investors fear fabled green shoots will turn out to be killer weeds.
On the other, they see a "wall of money," much of it from retail investors, driving up prices, and don't want to be left behind.
Perception is at odds with position -- a recipe for renewed market instability.
This is clear from recent investor surveys. European credit investors held record long positions in May, while also seeing high inflows, according to Citigroup and J.P. Morgan. Yet 60% of investors plan to reduce exposure or hold steady -- even as more than half expect to have more money to manage, according to J.P. Morgan.
Investor holdings are still concentrated in safer sectors such as telecommunications and utilities, and cash positions are way above average.
But new issuance is coming increasingly from companies with low credit ratings and in cyclical sectors like steel. Wide spreads on such offerings are attracting less risk-averse investors.
Meanwhile, conservative investors are missing out on the market rally.
Further evidence of this dissonance comes from credit default swaps, where spreads have widened even as cash bond spreads have continued tightening and demand for new issues has remained strong.
The CDX North American Investment Grade index has widened by 0.15 percentage point from its lows, while Merrill Lynch's corporate master bond index has tightened about 0.20 percentage point over the same period.
How will this conflict be resolved?
Much depends on retail investors, who are still piling into the market.
In the U.K., sterling corporate bond funds have been the top destination for retail investors every month since November, according to the Investment Management Association.
In the U.S., bond-fund inflows year-to-date added 6.5% to assets under management, TrimTabs Investment Research data show.
Allocations of new euro bond issues to retail buyers have jumped to 20% this year from 3% last year, according to Société Générale.
They are even leaping back into the bank capital market: Standard Chartered's $1.5 billion Tier 1 deal, sold largely to Asian retail investors, was six times oversubscribed this week.
What isn't clear is whether retail investors are a leading or a lagging indicator: Does their arrival signal the rally has further to run, or is it time for the smart money to exit?
For now, the technical factor of inflows trumps fundamental concerns over credit quality and the economy. But that could change if corporate bond yields rise -- either due to another shock or because underlying government bond yields climb -- and retail investors suffer.
At that point the balance of power could change, and bearish institutional investors may find their fears justified.
Write to Richard Barley at richard.barley@dowjones.com
What's Really Needed: Leverage Scorecard
By SCOTT PATTERSON
Regulators crafting new rules for the financial system also will need to develop tools to track one cause of the recent turmoil: leverage.
In 2006, the height of the boom, a bank purchasing a triple-A mortgage security valued at $100 needed to put up just $1.60 in cash -- the rest could be borrowed. Home buyers could get a mortgage with a 5% deposit, sometimes even less. Insurers such as American International Group sold bets known as derivatives to book fees for promises they ultimately couldn't keep, a hidden form of leverage.
Trouble is, there isn't a mechanism that monitors and publishes leverage in detail and systemwide. The Federal Reserve, closely focused on interest rates, tracks banks' fund flows but not daily leverage ratios at banks or hedge funds.
Leverage is as important as interest rates in fueling economic cycles, says Yale University economist John Geanakoplos, who has spent 15 years studying "leverage cycles" in the economy.
His solution: Regulators need to gather detailed, daily data directly from market participants such as banks and hedge funds -- and, more important, publish it in the aggregate. For instance, what is the average amount of collateral firms need to post to purchase a subprime-mortgage bond?
With such information readily available, investors and regulators could know whether the system is getting tipsy on leverage, he maintains.
"If everyone knows how leveraged everyone else is, it can make them nervous," causing investors to curb risk, said Mr. Geanakoplos, who also works for a hedge fund, Ellington Management Group.
The Obama administration's white paper on financial-market reforms is peppered with comments on leverage, so clearly officials are focused on the issue. One hurdle to greater transparency into systemic leverage could be getting banks and hedge funds to divulge highly guarded data.
Richard Bookstaber, a risk manager who has worked at these firms and who recently testified before Congress on how to monitor systemic risk, estimates that targeting the largest financial firms will cover roughly 80% of the risk.
"If you get 80% of the risk, you're going to be able to detect what's systemic," he said.
Email: tape@wsj.com
Regulators crafting new rules for the financial system also will need to develop tools to track one cause of the recent turmoil: leverage.
In 2006, the height of the boom, a bank purchasing a triple-A mortgage security valued at $100 needed to put up just $1.60 in cash -- the rest could be borrowed. Home buyers could get a mortgage with a 5% deposit, sometimes even less. Insurers such as American International Group sold bets known as derivatives to book fees for promises they ultimately couldn't keep, a hidden form of leverage.
Trouble is, there isn't a mechanism that monitors and publishes leverage in detail and systemwide. The Federal Reserve, closely focused on interest rates, tracks banks' fund flows but not daily leverage ratios at banks or hedge funds.
Leverage is as important as interest rates in fueling economic cycles, says Yale University economist John Geanakoplos, who has spent 15 years studying "leverage cycles" in the economy.
His solution: Regulators need to gather detailed, daily data directly from market participants such as banks and hedge funds -- and, more important, publish it in the aggregate. For instance, what is the average amount of collateral firms need to post to purchase a subprime-mortgage bond?
With such information readily available, investors and regulators could know whether the system is getting tipsy on leverage, he maintains.
"If everyone knows how leveraged everyone else is, it can make them nervous," causing investors to curb risk, said Mr. Geanakoplos, who also works for a hedge fund, Ellington Management Group.
The Obama administration's white paper on financial-market reforms is peppered with comments on leverage, so clearly officials are focused on the issue. One hurdle to greater transparency into systemic leverage could be getting banks and hedge funds to divulge highly guarded data.
Richard Bookstaber, a risk manager who has worked at these firms and who recently testified before Congress on how to monitor systemic risk, estimates that targeting the largest financial firms will cover roughly 80% of the risk.
"If you get 80% of the risk, you're going to be able to detect what's systemic," he said.
Email: tape@wsj.com
Stocks Sputter to Flat Finish
By PETER A. MCKAY and GEOFFREY ROGOW
Stocks lurched to a mixed finish as a rally in health-care firms was offset by losses in the financial sector after the Obama administration unveiled its regulatory revamp.
The Dow Jones Industrial Average, stuck in a tight range all day, declined 7.49 points, or 0.1%, to 8497.18. The Nasdaq Composite Index gained 11.88 points, or 0.7%, to 1808.06. The S&P 500 slipped 1.26 points, or 0.1%, to 910.71. Its health-care sector jumped 2.3%, but its financial sector dropped 2.9%.
Bank stocks fell after the White House unveiled its expected new regulatory plan. The plan gives increased power to the Federal Reserve and creates a new national regulator for financial firms while doing away with only one of the patchwork of agencies that now oversees the markets: the Office of Thrift Supervision.
Traders have been skeptical about the plan, doubting whether the effort will strike the right balance between curbing the excesses that led to the credit bubble while at the same time allowing firms to take steps to boost their profits.
"I don't see how it will work," said Michael Mainwald, head trader at Lek Securities, a New York brokerage. "The problems that are the most serious, like credit-default swaps, aren't really well understood by the people designing these plans."
Still, traders acknowledge both credit and stock markets have improved greatly since the major indexes in early March hit lows not seen since the 1990s. And from an economic standpoint, there are also improvements, though economists note there remains a long way to go.
"The stock market has correctly anticipated what's gone on in the economy with its recent gains by anticipating the change from worse to just bad," said Bob Baur, chief global economist for Principal Global Investors. "But the question remains -- are consumers really going to come back?"
On Wednesday, the government reported its consumer-price index rose 0.1% in May from April but fell 1.3% from a year ago, the largest 12-month decline since April 1950. The core CPI, which excludes food and energy prices, climbed 0.1% month over month. The data support the growing sentiment at the Federal Reserve that deflation risks have waned, but there's little evidence inflation is taking hold, a concern that has crept into bond markets in recent weeks.
Treasurys rallied on the tame May inflation report, bond purchases by the Federal Reserve and demand related to hedging in the mortgage-backed securities market.
Obama's announcement of forthcoming regulations for the financial industry put pressure on the sector. A handful of banks, including JP Morgan, Citigroup and Bank of America all finished lower. Dave Kansas reports after the bell.
Bonds were also supported by a statement from Standard & Poor's that said the U.S.'s triple-A credit ratings are unlikely to be cut any time soon. The rally further extended the rebound in Treasurys since late Thursday. The 10-year note's yield, which briefly broke above 4% Thursday, dipped to as low as 3.578% Wednesday.
In the stock market, in addition to the strong health-care sector, consumer stocks were also higher on the session, bouncing back from a Tuesday slide.
But some signs of trouble did surface. Retailer Eddie Bauer filed for Chapter 11 bankruptcy protection and said it will be acquired by private-equity firm CCMP Capital Advisors.
In the agriculture sector, a profit warning from German fertilizer company K+S AG sparked a selloff that spread to other names. Potash Corp. of Saskatchewan fell 11%. Agrium sank 7.4%, while Archer Daniels Midland declined 2%.
The week so far has been dominated by big moves in the last hour of trading, with traders expecting that trend to continue on Wednesday and Thursday. Notably, Friday marks triple-witching -- the expiration of stock-index options, options on individual names and stock-index futures. In addition, quarterly rebalancing for the S&P ADR Indices will be updated at the close on Friday.
"A lot of people are playing a bullish/bearish game throughout the week, setting up for triple witching and rebalance on Friday," said Robert Weinstein, senior managing director for Lighthouse Financial Group. "But once we enter the summer, you'll see some of this volatile movement dry up."
While the financial sector was under pressure, some investors were hopeful following the announcement that J.P. Morgan Chase, Goldman Sachs Group and Morgan Stanley have bought back preferred shares they issued to the government under last fall's bailout effort.
Goldman sank 3% following the news, while the other two companies were off more than 2%.
"I really think this is a case of people selling on the news, since we've been anticipating repayment for so long," with many participants placing bets well ahead of the actual announcements, said portfolio manager Uri Landesman, of ING Investment Management. "Over the long term, though, this is a very promising sign that things are getting back to normal."
In other markets, both energy and metals prices erased morning declines and closed slightly to the upside, helping oil and materials companies pare some of their morning declines.
—Min Zeng contributed to this article.
Write to Peter A. McKay at peter.mckay@wsj.com and Geoffrey Rogow at geoffrey.rogow@dowjones.com
Stocks lurched to a mixed finish as a rally in health-care firms was offset by losses in the financial sector after the Obama administration unveiled its regulatory revamp.
The Dow Jones Industrial Average, stuck in a tight range all day, declined 7.49 points, or 0.1%, to 8497.18. The Nasdaq Composite Index gained 11.88 points, or 0.7%, to 1808.06. The S&P 500 slipped 1.26 points, or 0.1%, to 910.71. Its health-care sector jumped 2.3%, but its financial sector dropped 2.9%.
Bank stocks fell after the White House unveiled its expected new regulatory plan. The plan gives increased power to the Federal Reserve and creates a new national regulator for financial firms while doing away with only one of the patchwork of agencies that now oversees the markets: the Office of Thrift Supervision.
Traders have been skeptical about the plan, doubting whether the effort will strike the right balance between curbing the excesses that led to the credit bubble while at the same time allowing firms to take steps to boost their profits.
"I don't see how it will work," said Michael Mainwald, head trader at Lek Securities, a New York brokerage. "The problems that are the most serious, like credit-default swaps, aren't really well understood by the people designing these plans."
Still, traders acknowledge both credit and stock markets have improved greatly since the major indexes in early March hit lows not seen since the 1990s. And from an economic standpoint, there are also improvements, though economists note there remains a long way to go.
"The stock market has correctly anticipated what's gone on in the economy with its recent gains by anticipating the change from worse to just bad," said Bob Baur, chief global economist for Principal Global Investors. "But the question remains -- are consumers really going to come back?"
On Wednesday, the government reported its consumer-price index rose 0.1% in May from April but fell 1.3% from a year ago, the largest 12-month decline since April 1950. The core CPI, which excludes food and energy prices, climbed 0.1% month over month. The data support the growing sentiment at the Federal Reserve that deflation risks have waned, but there's little evidence inflation is taking hold, a concern that has crept into bond markets in recent weeks.
Treasurys rallied on the tame May inflation report, bond purchases by the Federal Reserve and demand related to hedging in the mortgage-backed securities market.
Obama's announcement of forthcoming regulations for the financial industry put pressure on the sector. A handful of banks, including JP Morgan, Citigroup and Bank of America all finished lower. Dave Kansas reports after the bell.
Bonds were also supported by a statement from Standard & Poor's that said the U.S.'s triple-A credit ratings are unlikely to be cut any time soon. The rally further extended the rebound in Treasurys since late Thursday. The 10-year note's yield, which briefly broke above 4% Thursday, dipped to as low as 3.578% Wednesday.
In the stock market, in addition to the strong health-care sector, consumer stocks were also higher on the session, bouncing back from a Tuesday slide.
But some signs of trouble did surface. Retailer Eddie Bauer filed for Chapter 11 bankruptcy protection and said it will be acquired by private-equity firm CCMP Capital Advisors.
In the agriculture sector, a profit warning from German fertilizer company K+S AG sparked a selloff that spread to other names. Potash Corp. of Saskatchewan fell 11%. Agrium sank 7.4%, while Archer Daniels Midland declined 2%.
The week so far has been dominated by big moves in the last hour of trading, with traders expecting that trend to continue on Wednesday and Thursday. Notably, Friday marks triple-witching -- the expiration of stock-index options, options on individual names and stock-index futures. In addition, quarterly rebalancing for the S&P ADR Indices will be updated at the close on Friday.
"A lot of people are playing a bullish/bearish game throughout the week, setting up for triple witching and rebalance on Friday," said Robert Weinstein, senior managing director for Lighthouse Financial Group. "But once we enter the summer, you'll see some of this volatile movement dry up."
While the financial sector was under pressure, some investors were hopeful following the announcement that J.P. Morgan Chase, Goldman Sachs Group and Morgan Stanley have bought back preferred shares they issued to the government under last fall's bailout effort.
Goldman sank 3% following the news, while the other two companies were off more than 2%.
"I really think this is a case of people selling on the news, since we've been anticipating repayment for so long," with many participants placing bets well ahead of the actual announcements, said portfolio manager Uri Landesman, of ING Investment Management. "Over the long term, though, this is a very promising sign that things are getting back to normal."
In other markets, both energy and metals prices erased morning declines and closed slightly to the upside, helping oil and materials companies pare some of their morning declines.
—Min Zeng contributed to this article.
Write to Peter A. McKay at peter.mckay@wsj.com and Geoffrey Rogow at geoffrey.rogow@dowjones.com
Public Wary of Deficit, Economic Intervention
By LAURA MECKLER
WASHINGTON -- After a fairly smooth opening, President Barack Obama faces new concerns among the American public about the budget deficit and government intervention in the economy as he works to enact ambitious health and energy legislation, a new Wall Street Journal/NBC News poll finds.
These rising doubts threaten to overshadow the president's personal popularity and his agenda, in what may be a new phase of the Obama presidency.
"The public is really moving from evaluating him as a charismatic and charming leader to his specific handling of the challenges facing the country," says Peter D. Hart, a Democratic pollster who conducts the survey with Republican Bill McInturff. Going forward, he says, Mr. Obama and his allies "are going to have to navigate in pretty choppy waters."
There's good news for the administration, too, including tentative support for Mr. Obama's health-care plan and approval of his nominee for the Supreme Court. The public seems more optimistic about the country's economic future than it did a few weeks earlier, and Americans are still more likely to blame the last administration for the deficit.
But the poll suggests Mr. Obama faces challenges on multiple fronts, including growing concerns about government spending and the bailout of auto companies. A majority of people also disapprove of his decision to close the military prison at Guantanamo Bay, Cuba.
Nearly seven in 10 survey respondents said they had concerns about federal interventions into the economy, including Mr. Obama's decision to take an ownership stake in General Motors Corp., limits on executive compensation and the prospect of more government involvement in health care. The negative feeling toward the GM rescue was reflected elsewhere in the survey as well.
A solid majority -- 58% -- said that the president and Congress should focus on keeping the budget deficit down, even if takes longer for the economy to recover.
Laura Zamora, 40, of Orange, Calif., voted for Mr. Obama but says she is frustrated by the economy and finds her support for the president waning. She says she's facing a possible layoff as a local government worker in California.
"He's bailing out the private sector. He's putting all kinds of money into the private sector," says Mrs. Zamora. "The money should be going to social programs, not to bailing out banks and GM. It should go to people who are unemployed."
The survey of 1,008 adults, conducted Friday to Monday, had a margin of error of plus or minus 3.1 percentage points for the full sample.
The results come after weeks of Republican hammering of Mr. Obama for spending too much and taking on too many issues, arguments that appear to be resonating with some voters.
Mr. Obama's overall job approval and personal ratings have slipped, particularly among independent voters. His job approval rating now stands at 56%, down from 61% in April. Among independents, it dropped from nearly two-to-one approval to closely divided.
In an interview with The Wall Street Journal, President Obama acknowledged the toll.
"If you have an argument made frequently enough -- whether it's true or not -- it has some impact," he said Tuesday. "If you want to attack a Democratic president, how are you going to attack him? Well, you're going to talk about how he wants more government and he wants to socialize medicine and he's going to be oppressive towards business. I mean, that's pretty standard fare."
Mr. Obama ran down some of problems he said he had been forced to deal with, and said the real argument is about whether to take on health care and energy.
"I suppose we could just stand pat and not do anything on either of those fronts...That's been tried for four or five decades. And in both energy and health care, the problems have gotten worse, not better," he said.
By some measures, the public seems to agree. Only 37% of people said that Mr. Obama is taking on too many issues. A solid majority -- 60% -- said that he is focused on many issues because the country is facing so many problems.
The president and his advisers appear to be aware of the peril they face over the deficit. That helps explain why Mr. Obama has emphasized his effort to cut health-care costs over his effort to expand health-insurance coverage, and why he has promised that the cost of any health-care package will be covered by spending cuts or tax increases.
When asked what the most important economic issue facing the country is, 24% cited the deficit, vs. just 11% who named health care.
Mr. Obama has some breathing room. Nearly three in four respondents said that the president inherited the current economic conditions, versus just 14% who said he is responsible for them. Only 6% said the Obama administration is most responsible for the budget deficit. Nearly half blame the Bush administration.
On the economy, the poll had some bright spots, with a rising expectation of recovery. The portion of people who think the economy will improve over the next 12 months rose to 46% from 38% in April. And 20% predicted the recession would end in six months to a year, nearly double the comparable figure from April.
Still, overall, the public finds the economy in dreadful shape today, and people living in the Midwest were much less likely to express optimism about the future than those on the coasts.
On health care, the public remains open to persuasion. Without being told anything specific about the Obama plan in the survey, about a third of people said it's a good idea, about a third said it's a bad idea and the rest had no opinion. When given several details of his approach, 55% said they favored it, versus 35% who were opposed.
There was also support for the Democratic push to let people sign up for a public health-care plan that would compete with private companies, one of the toughest issues in the health-care debate. Three in four people said a public plan is extremely or quite important. But when told the arguments for and against the plan, a smaller portion, 47%, agreed with arguments in support of the plan, with 42% agreeing with the arguments against it.
At the same time, nearly half the participants said it was very or somewhat likely that their employer would drop private coverage if a public plan were available.
As for how to pay for the package, estimated at more than $1 trillion over 10 years, the public favors proposals to require all Americans to get insurance, to raise taxes on the rich and, to a lesser extent, to require all but the smallest businesses to offer insurance or pay into a fund.
But majorities oppose plans to tax health benefits, even if the taxes only apply to particularly generous plans. The public is divided about cuts to Medicare.
Regarding Mr. Obama's pick to the Supreme Court, Judge Sonia Sotomayor, half the public said she's qualified for the post, versus just 13% who said she's not qualified. That's equivalent to numbers in November 2005 for Samuel Alito, Mr. Bush's nominee who was subsequently confirmed to the court.
One in three people said her decisions and views seem out of the mainstream, vs. 28% who say they are in the mainstream. The rest had no opinion. But overall support for her confirmation is strong.
There was some good news for General Motors, despite the widespread antipathy to using taxpayer money to aid the company. More than half the participants said they are considering or have recently considered buying an American car. Of those people, 40% said the recent problems of the U.S. auto industry make them more likely to buy American. Just 14% said it made them less likely.
—Jake Sherman contributed to this article.
Write to Laura Meckler at laura.meckler@wsj.com
WASHINGTON -- After a fairly smooth opening, President Barack Obama faces new concerns among the American public about the budget deficit and government intervention in the economy as he works to enact ambitious health and energy legislation, a new Wall Street Journal/NBC News poll finds.
These rising doubts threaten to overshadow the president's personal popularity and his agenda, in what may be a new phase of the Obama presidency.
"The public is really moving from evaluating him as a charismatic and charming leader to his specific handling of the challenges facing the country," says Peter D. Hart, a Democratic pollster who conducts the survey with Republican Bill McInturff. Going forward, he says, Mr. Obama and his allies "are going to have to navigate in pretty choppy waters."
There's good news for the administration, too, including tentative support for Mr. Obama's health-care plan and approval of his nominee for the Supreme Court. The public seems more optimistic about the country's economic future than it did a few weeks earlier, and Americans are still more likely to blame the last administration for the deficit.
But the poll suggests Mr. Obama faces challenges on multiple fronts, including growing concerns about government spending and the bailout of auto companies. A majority of people also disapprove of his decision to close the military prison at Guantanamo Bay, Cuba.
Nearly seven in 10 survey respondents said they had concerns about federal interventions into the economy, including Mr. Obama's decision to take an ownership stake in General Motors Corp., limits on executive compensation and the prospect of more government involvement in health care. The negative feeling toward the GM rescue was reflected elsewhere in the survey as well.
A solid majority -- 58% -- said that the president and Congress should focus on keeping the budget deficit down, even if takes longer for the economy to recover.
Laura Zamora, 40, of Orange, Calif., voted for Mr. Obama but says she is frustrated by the economy and finds her support for the president waning. She says she's facing a possible layoff as a local government worker in California.
"He's bailing out the private sector. He's putting all kinds of money into the private sector," says Mrs. Zamora. "The money should be going to social programs, not to bailing out banks and GM. It should go to people who are unemployed."
The survey of 1,008 adults, conducted Friday to Monday, had a margin of error of plus or minus 3.1 percentage points for the full sample.
The results come after weeks of Republican hammering of Mr. Obama for spending too much and taking on too many issues, arguments that appear to be resonating with some voters.
Mr. Obama's overall job approval and personal ratings have slipped, particularly among independent voters. His job approval rating now stands at 56%, down from 61% in April. Among independents, it dropped from nearly two-to-one approval to closely divided.
In an interview with The Wall Street Journal, President Obama acknowledged the toll.
"If you have an argument made frequently enough -- whether it's true or not -- it has some impact," he said Tuesday. "If you want to attack a Democratic president, how are you going to attack him? Well, you're going to talk about how he wants more government and he wants to socialize medicine and he's going to be oppressive towards business. I mean, that's pretty standard fare."
Mr. Obama ran down some of problems he said he had been forced to deal with, and said the real argument is about whether to take on health care and energy.
"I suppose we could just stand pat and not do anything on either of those fronts...That's been tried for four or five decades. And in both energy and health care, the problems have gotten worse, not better," he said.
By some measures, the public seems to agree. Only 37% of people said that Mr. Obama is taking on too many issues. A solid majority -- 60% -- said that he is focused on many issues because the country is facing so many problems.
The president and his advisers appear to be aware of the peril they face over the deficit. That helps explain why Mr. Obama has emphasized his effort to cut health-care costs over his effort to expand health-insurance coverage, and why he has promised that the cost of any health-care package will be covered by spending cuts or tax increases.
When asked what the most important economic issue facing the country is, 24% cited the deficit, vs. just 11% who named health care.
Mr. Obama has some breathing room. Nearly three in four respondents said that the president inherited the current economic conditions, versus just 14% who said he is responsible for them. Only 6% said the Obama administration is most responsible for the budget deficit. Nearly half blame the Bush administration.
On the economy, the poll had some bright spots, with a rising expectation of recovery. The portion of people who think the economy will improve over the next 12 months rose to 46% from 38% in April. And 20% predicted the recession would end in six months to a year, nearly double the comparable figure from April.
Still, overall, the public finds the economy in dreadful shape today, and people living in the Midwest were much less likely to express optimism about the future than those on the coasts.
On health care, the public remains open to persuasion. Without being told anything specific about the Obama plan in the survey, about a third of people said it's a good idea, about a third said it's a bad idea and the rest had no opinion. When given several details of his approach, 55% said they favored it, versus 35% who were opposed.
There was also support for the Democratic push to let people sign up for a public health-care plan that would compete with private companies, one of the toughest issues in the health-care debate. Three in four people said a public plan is extremely or quite important. But when told the arguments for and against the plan, a smaller portion, 47%, agreed with arguments in support of the plan, with 42% agreeing with the arguments against it.
At the same time, nearly half the participants said it was very or somewhat likely that their employer would drop private coverage if a public plan were available.
As for how to pay for the package, estimated at more than $1 trillion over 10 years, the public favors proposals to require all Americans to get insurance, to raise taxes on the rich and, to a lesser extent, to require all but the smallest businesses to offer insurance or pay into a fund.
But majorities oppose plans to tax health benefits, even if the taxes only apply to particularly generous plans. The public is divided about cuts to Medicare.
Regarding Mr. Obama's pick to the Supreme Court, Judge Sonia Sotomayor, half the public said she's qualified for the post, versus just 13% who said she's not qualified. That's equivalent to numbers in November 2005 for Samuel Alito, Mr. Bush's nominee who was subsequently confirmed to the court.
One in three people said her decisions and views seem out of the mainstream, vs. 28% who say they are in the mainstream. The rest had no opinion. But overall support for her confirmation is strong.
There was some good news for General Motors, despite the widespread antipathy to using taxpayer money to aid the company. More than half the participants said they are considering or have recently considered buying an American car. Of those people, 40% said the recent problems of the U.S. auto industry make them more likely to buy American. Just 14% said it made them less likely.
—Jake Sherman contributed to this article.
Write to Laura Meckler at laura.meckler@wsj.com
Wednesday, June 17, 2009
Historic Overhaul of Finance Rules
By DAMIAN PALETTA
WASHINGTON -- President Barack Obama urged policy makers to rewrite the rules governing U.S. finance, unveiling far-reaching proposals that would affect nearly every aspect of banking and markets.
The White House hopes Congress can complete work on the plan by year's end. But it is sure to face opposition both from some on the right who say it threatens to throttle free markets and others on the left who say it doesn't go far enough. Some in Congress are cautioning against haste.
The proposals are the latest instance of the administration seeking to expand its reach in the private sector. White House officials said the trauma of the current crisis shows a more muscular federal arsenal is needed to protect the financial system.
"Millions of Americans who have worked hard and behaved responsibly have seen their life dreams eroded by the irresponsibility of others and by the failure of their government to provide adequate oversight," Mr. Obama said. "Our entire economy has been undermined by that failure."
The administration's vision would have consumers offered more "plain vanilla" financial products. A new agency would regulate financial products for consumers, such as mortgages.
There would be rules designed to mitigate booms and busts, a goal often sought but rarely reached. The U.S. would gain powers to take over tottering financial giants and supervise firms that could pose a threat to financial stability, even those that don't own banks.
Executive compensation and hedge funds would face more scrutiny. Bank regulation would be streamlined somewhat. Financial firms would be required to hold more capital.
On Wall Street, there was relief the proposals were not more draconian, along with a realization the reduced appetite for risk that took hold after the crisis might be a long-term feature of the landscape.
The process now heads to Capitol Hill. One tenet of the new plan has already made some lawmakers uncomfortable: a push to centralize more power in the Federal Reserve.
Banks, which are expected to lobby hard as the bill moves through Congress, have resisted the provision that would create a new consumer agency. The industry argues it could stifle innovation and make loans more expensive.
Treasury Secretary Timothy Geithner will get an early sense of the reception Thursday when he testifies before two congressional committees.
"Haste is dangerous, especially when you are dealing with comprehensive change in our financial system," said Republican Sen. Richard Shelby of Alabama, a conservative on such matters. "This could be the most important piece of legislation that we've had in the banking committee in 50 years."
WASHINGTON -- President Barack Obama urged policy makers to rewrite the rules governing U.S. finance, unveiling far-reaching proposals that would affect nearly every aspect of banking and markets.
The White House hopes Congress can complete work on the plan by year's end. But it is sure to face opposition both from some on the right who say it threatens to throttle free markets and others on the left who say it doesn't go far enough. Some in Congress are cautioning against haste.
The proposals are the latest instance of the administration seeking to expand its reach in the private sector. White House officials said the trauma of the current crisis shows a more muscular federal arsenal is needed to protect the financial system.
"Millions of Americans who have worked hard and behaved responsibly have seen their life dreams eroded by the irresponsibility of others and by the failure of their government to provide adequate oversight," Mr. Obama said. "Our entire economy has been undermined by that failure."
The administration's vision would have consumers offered more "plain vanilla" financial products. A new agency would regulate financial products for consumers, such as mortgages.
There would be rules designed to mitigate booms and busts, a goal often sought but rarely reached. The U.S. would gain powers to take over tottering financial giants and supervise firms that could pose a threat to financial stability, even those that don't own banks.
Executive compensation and hedge funds would face more scrutiny. Bank regulation would be streamlined somewhat. Financial firms would be required to hold more capital.
On Wall Street, there was relief the proposals were not more draconian, along with a realization the reduced appetite for risk that took hold after the crisis might be a long-term feature of the landscape.
The process now heads to Capitol Hill. One tenet of the new plan has already made some lawmakers uncomfortable: a push to centralize more power in the Federal Reserve.
Banks, which are expected to lobby hard as the bill moves through Congress, have resisted the provision that would create a new consumer agency. The industry argues it could stifle innovation and make loans more expensive.
Treasury Secretary Timothy Geithner will get an early sense of the reception Thursday when he testifies before two congressional committees.
"Haste is dangerous, especially when you are dealing with comprehensive change in our financial system," said Republican Sen. Richard Shelby of Alabama, a conservative on such matters. "This could be the most important piece of legislation that we've had in the banking committee in 50 years."
How does the current crisis match up against past crises. It is the worst since 2nd world war, but far milder than Great Depression.
http://www.cfr.org/content/publications/attachments/2009OutlookFinal_Long.pdf
http://www.cfr.org/content/publications/attachments/2009OutlookFinal_Long.pdf
中国的公共债务压力超出预期
说到中国公共债务的实际水平，高于预期的财政赤字可能仅仅是冰山一角。
与美国、欧盟和日本相比，中国在经济增长放缓之际的公共财政状况要好些。拜几年来逐步收紧的财政政策所赐，中国的财政小有盈余，政府在通过公共支出推动经济摆脱低迷方面处于有利位置。财政部预计中国2009年将出现人民币9,500亿元的财政赤字，相当于当年国内生产总值(GDP)的2.9%，接近其自我设置的比例上限。这一赤字规模将使中央政府的债务额达到人民币6.3276万亿元，大约相当于中国GDP的19.5%。
但从今年迄今为止的政府税收和支出数据看，虽然政府开支的增速高于预期，但政府的收入却显著低于预期。中国今年3月公布的2009年中央财政预算提供了中央政府对今年税收收入的预期值。该报告预计，中央和地方政府今年的收入将达到人民币6.623万亿元，比2008年增长8%。而截至今年5月，中国政府的总收入为人民币2.7108万亿元，比上年同期下降6.7%。
税收中的几个大类别都低于预期。2009年中央政府超过70%的税收收入预计都将来自国内增值税、进口税、企业税和个人所得税收入，政府原本预计这几类税收都将比2008年有所增长。今年5月，政府的增值税、进口税和企业税收入都低于上年同期。个人所得税收入只比上年同期增长0.9%，而政府在预算报告中原本预计这项收入会增长7%。财政部认为，经济增长放缓、企业盈利能力薄弱以及政府运用税收手段来刺激经济，是造成税收减少的主要原因。
而政府支出的增长速度却快于预期。根据中央财政预算，今年政府的总支出为人民币7.6235万亿元，比2008年增长22.1%。而今年截至5月份，政府的总支出已达到人民币2.2496万亿元，较上年同期增长27.8%。由于税收收入低于预期而政府支出增速却快于预期，中国今年的公共财政前景黯淡。财政部坦率表示，财政收不抵支的矛盾将逐步凸显出来，全年财政收支形势严峻
如果政府的收入状况继续恶化而政府今年的支出增速继续保持目前水平，那么中国今年的财政赤字将大大超过政府预计的人民币9,500亿元水平。事实上，如果政府今年全年的收入下降幅度和支出增速维持在今年前四个月的水平，那么政府今年的财政赤字将超过人民币2万亿元(相当于GDP的6.2%)。但如果政府今年的支出足以推动经济加快增长，而政府的税收今年晚些时候又会随着经济的复苏而增加，那么上述预期就太过悲观了。政府5月份的收支状况实际上已比此前几个月略有改善。当月的税收略有增加，而支出则出现了下降。但不管情况如何，目前看来政府今年是不大可能将财政赤字控制在目标水平之下的。
面对经济低迷，扩张性的财政政策显然是最明智的，而在经济快速增长的时候，即使财政赤字高于预期也不足为虑。然而，随着中国经济进入很可能延续较长时间的低速增长期，较高的财政赤字，加上对地方政府债务水平的担忧以及银行系统坏帐的不确定性，这些都加剧了对公共债务实际水平的担忧。
地方政府债务水平极高早就是公开的秘密。由于不遵守财政纪律，收入来源有限且不稳定，同时在医疗和教育方面又要加大开支，地方政府在当前的经济低迷开始之际就已经背负着财政赤字，有的地方债务与GDP的比率处于令人担忧的水平。一家与政府有关的研究机构估计地方债务总额相当于GDP的16.5%。由于经济低迷意味着税收收入和土地出让收入的减少，同时在社会福利和经济刺激项目方面的开支加大，地方政府的债务正在进一步加剧。虽然财政部发行了人民币2,000亿元的地方债务也无济于事。
除了中央和地方各级政府的债务，政府还面临规模不明的临时负债，即银行系统中的不良贷款。据估计，亚洲金融危机结束时，不良贷款相当于GDP的40%以上。在政府出台多种代价高昂的干预措施，清理了银行的资产负债表之后，不良贷款才降到了当前的水平。现在，不良贷款就像恐怖电影里的反派一样，你以为他已经死了，结果在续集里又出现了。没有人认为不良贷款将会攀升至上世纪90年代末的水平。但今年头5个月新增贷款迅猛增长，其中有很大一部分贷款的发放是出于政治和商业的双重理由，几乎可以肯定，这些贷款将会在银行资产负债表上造成大量坏帐，最终成为政府的包袱。
粗略的计算显示，公共债务的真正水平大大超出了预算中显示的相当于GDP 19.5%的比例。远远高于预期的财政赤字，很可能与中央政府债务相当的地方债务，以及银行系统不良贷款带来的临时负债都需要加进去。实际的债务将超过GDP的40%，是中央政府债务总额与GDP比率的两倍以上。随着经济进入长期的低速增长，政府无法通过扩大税收收入来偿付债务。
公共债务会成为后人的包袱，债务越多，包袱就会越重。用来偿付债务的资金无法用于医疗、教育和其他公共福利开支。财政在经济形势好的时候从紧、形势不好的时候扩张是合理的经济政策。但如果对中国目前的债务水平如何、还将背负多少债务没有一个明确的概念，政策决策者和中国民众就很难在权衡当前利益和未来借贷成本时做出正确的决策。公共债务真实水平的不确定性为防止它脱离掌控增加了难度。要解决问题，政府明确公布公共债务的真实水平将会是至关重要的第一步。
（编者按：本文作者Tom Orlik是SMRA China的首席经济学家，现居北京。）
与美国、欧盟和日本相比，中国在经济增长放缓之际的公共财政状况要好些。拜几年来逐步收紧的财政政策所赐，中国的财政小有盈余，政府在通过公共支出推动经济摆脱低迷方面处于有利位置。财政部预计中国2009年将出现人民币9,500亿元的财政赤字，相当于当年国内生产总值(GDP)的2.9%，接近其自我设置的比例上限。这一赤字规模将使中央政府的债务额达到人民币6.3276万亿元，大约相当于中国GDP的19.5%。
但从今年迄今为止的政府税收和支出数据看，虽然政府开支的增速高于预期，但政府的收入却显著低于预期。中国今年3月公布的2009年中央财政预算提供了中央政府对今年税收收入的预期值。该报告预计，中央和地方政府今年的收入将达到人民币6.623万亿元，比2008年增长8%。而截至今年5月，中国政府的总收入为人民币2.7108万亿元，比上年同期下降6.7%。
税收中的几个大类别都低于预期。2009年中央政府超过70%的税收收入预计都将来自国内增值税、进口税、企业税和个人所得税收入，政府原本预计这几类税收都将比2008年有所增长。今年5月，政府的增值税、进口税和企业税收入都低于上年同期。个人所得税收入只比上年同期增长0.9%，而政府在预算报告中原本预计这项收入会增长7%。财政部认为，经济增长放缓、企业盈利能力薄弱以及政府运用税收手段来刺激经济，是造成税收减少的主要原因。
而政府支出的增长速度却快于预期。根据中央财政预算，今年政府的总支出为人民币7.6235万亿元，比2008年增长22.1%。而今年截至5月份，政府的总支出已达到人民币2.2496万亿元，较上年同期增长27.8%。由于税收收入低于预期而政府支出增速却快于预期，中国今年的公共财政前景黯淡。财政部坦率表示，财政收不抵支的矛盾将逐步凸显出来，全年财政收支形势严峻
如果政府的收入状况继续恶化而政府今年的支出增速继续保持目前水平，那么中国今年的财政赤字将大大超过政府预计的人民币9,500亿元水平。事实上，如果政府今年全年的收入下降幅度和支出增速维持在今年前四个月的水平，那么政府今年的财政赤字将超过人民币2万亿元(相当于GDP的6.2%)。但如果政府今年的支出足以推动经济加快增长，而政府的税收今年晚些时候又会随着经济的复苏而增加，那么上述预期就太过悲观了。政府5月份的收支状况实际上已比此前几个月略有改善。当月的税收略有增加，而支出则出现了下降。但不管情况如何，目前看来政府今年是不大可能将财政赤字控制在目标水平之下的。
面对经济低迷，扩张性的财政政策显然是最明智的，而在经济快速增长的时候，即使财政赤字高于预期也不足为虑。然而，随着中国经济进入很可能延续较长时间的低速增长期，较高的财政赤字，加上对地方政府债务水平的担忧以及银行系统坏帐的不确定性，这些都加剧了对公共债务实际水平的担忧。
地方政府债务水平极高早就是公开的秘密。由于不遵守财政纪律，收入来源有限且不稳定，同时在医疗和教育方面又要加大开支，地方政府在当前的经济低迷开始之际就已经背负着财政赤字，有的地方债务与GDP的比率处于令人担忧的水平。一家与政府有关的研究机构估计地方债务总额相当于GDP的16.5%。由于经济低迷意味着税收收入和土地出让收入的减少，同时在社会福利和经济刺激项目方面的开支加大，地方政府的债务正在进一步加剧。虽然财政部发行了人民币2,000亿元的地方债务也无济于事。
除了中央和地方各级政府的债务，政府还面临规模不明的临时负债，即银行系统中的不良贷款。据估计，亚洲金融危机结束时，不良贷款相当于GDP的40%以上。在政府出台多种代价高昂的干预措施，清理了银行的资产负债表之后，不良贷款才降到了当前的水平。现在，不良贷款就像恐怖电影里的反派一样，你以为他已经死了，结果在续集里又出现了。没有人认为不良贷款将会攀升至上世纪90年代末的水平。但今年头5个月新增贷款迅猛增长，其中有很大一部分贷款的发放是出于政治和商业的双重理由，几乎可以肯定，这些贷款将会在银行资产负债表上造成大量坏帐，最终成为政府的包袱。
粗略的计算显示，公共债务的真正水平大大超出了预算中显示的相当于GDP 19.5%的比例。远远高于预期的财政赤字，很可能与中央政府债务相当的地方债务，以及银行系统不良贷款带来的临时负债都需要加进去。实际的债务将超过GDP的40%，是中央政府债务总额与GDP比率的两倍以上。随着经济进入长期的低速增长，政府无法通过扩大税收收入来偿付债务。
公共债务会成为后人的包袱，债务越多，包袱就会越重。用来偿付债务的资金无法用于医疗、教育和其他公共福利开支。财政在经济形势好的时候从紧、形势不好的时候扩张是合理的经济政策。但如果对中国目前的债务水平如何、还将背负多少债务没有一个明确的概念，政策决策者和中国民众就很难在权衡当前利益和未来借贷成本时做出正确的决策。公共债务真实水平的不确定性为防止它脱离掌控增加了难度。要解决问题，政府明确公布公共债务的真实水平将会是至关重要的第一步。
（编者按：本文作者Tom Orlik是SMRA China的首席经济学家，现居北京。）
Black Swan Trader Bets Reputation on Inflation
By SCOTT PATTERSON
Mark Spitznagel made a fortune predicting the "black swan" that hit markets last year. Now the relatively unknown hedge-fund manager is emerging from the shadow of his collaborator, Nassim Nicholas Taleb, with a big bet inflation will soar.
The 38-year old Mr. Spitznagel managed the Black Swan funds to triple digit returns last year with a bet on volatility. The returns have brought a flood of cash, sending assets for his firm, Universa Investments LP, rising to $6 billion from $300 million.
But, for all the gains, Mr. Spitznagel is still far less known than "Black Swan" author Mr. Taleb, who invests in the funds and helps shape their strategies but doesn't manage the money.
Susan Hall
Mark Spitznagel sees economic stimulus efforts spurring inflation.
"Black swan" alludes to the once-widespread belief that all swans are white -- proved false when European explorers found black swans in Australia. A black-swan event is something extreme and highly unexpected.
Mr. Spitznagel's winning streak now will be tested. Universa is poised to make a huge wager that will reap big rewards if inflation surges. Inflation is on investors' radar thanks to extensive economic stimulus efforts.
"The consequences of the monetary bender the government has put on could be huge," Mr. Spitznagel says.
The new fund, expected to start trading in July, will place bets on options tied to assets expected to benefit from a big leap in prices, including commodities such as corn and crude oil, and options on shares of oil drillers and gold miners. It also will short Treasury bonds, likely to weaken in an inflationary economy.
The inflation bet marks a change for Universa. Typically, Messrs. Spitznagel and Taleb don't have an opinion about the near-term direction of the markets or economy. Rather, they argue, investors tend to underestimate the risks of major market swings. The latest wager is more of a directional bet that regulators' efforts to prop up the financial sector and the broader economy will spark inflation.
Mr. Spitznagel's approach to trading dates to his time as a fledgling pit trader in the early 1990s at the Chicago Board of Trade, where he bought and sold commodities such as cotton and soybeans.
Mr. Spitznagel's mentor, commodity-trading veteran Everett Klipp, trained him to limit losses by having him immediately exit trades as soon as they moved against him.
The notion of quickly folding a hand is alien to many traders who insist the market will come around to their point of view, says Mr. Klipp, 82, who retired several years ago. "You don't argue with the market," he said in an interview.
In the late 1990s, Mr. Spitznagel moved to New York to take courses at New York University, where Mr. Taleb taught. Mr. Taleb was planning to launch a hedge fund in which he would buy far out-of-the-money "put" options that would pay off if the market plunged sharply. Usually it didn't, and the options expired worthless, generating small losses. Options give their owner the right, but not the obligation, to buy or sell a stock at a certain price.
"One thing Mark taught me was that when someone isn't afraid of losing small amounts, they're almost invincible" because they have more staying power, Mr. Taleb said.
The strategy often either looses money or posts flat returns, which can turn off investors. Though the fund Mr. Taleb launched, Empirica Capital, initially made some money, when volatility fell its returns did, too. Burned out by the day-to-day trading grind, Mr. Taleb in 2004 closed down Empirica and concentrated on writing.
Mr. Spitznagel, meanwhile, joined a Morgan Stanley trading unit called Process Driven Trading. Not inclined to meet the bank's request that he sign a stringent "noncompete" agreement, he left Morgan in early 2007 and started to lay the groundwork for Universa.
Universa started trading out of a small office in Santa Monica, Calif., a location Mr. Spitznagel selected partly because of its distance from Wall Street. Mr. Spitznagel doesn't read financial news; rather, he developed software programs that troll options markets for deals.
A small group of mathematically trained traders track the programs, frequently discussing which trades to make with Mr. Spitznagel. Only 14 people work at the firm, though more will be hired for the inflation funds.
From time to time, a Chinese expert in tai chi visits the fund to train Mr. Spitznagel in the martial art, specifically the idea of using an opponent's force again him. Mr. Spitznagel sees similarities between the technique and his trading strategy, he says, since he believes the small losses he takes can eventually give him leverage over traders on the other side of his positions.
Mr. Spitznagel's strategy gained an advantage last year as the turmoil in subprime mortgages turned into a rout. In late September, he was meeting a client outside Chicago while keeping track of the market on his BlackBerry. Investors were on edge as Congress voted on the Treasury Department's $700 billion financial-rescue package.
Suddenly, the market plunged after the House voted it down. Mr. Spitznagel rushed back to his hotel to field calls from investors and manage the fund's positions from a laptop along with traders at Universa's headquarters.
During the next few months, Universa's positions surged in value. Investors piled in, eager for protection as the market spiraled lower. In early 2009, Mr. Spitznagel closed the strategy to new investors.
Now, Universa faces the risk that a quick market recovery eases investors' concerns about another crash. Mr. Spitznagel says that would be a mistake.
"People have been very quick to think that the low is in," he said. "They've lost all perspective on what a bear market can look like and how long it can last."
Write to Scott Patterson at scott.patterson@wsj.com
Mark Spitznagel made a fortune predicting the "black swan" that hit markets last year. Now the relatively unknown hedge-fund manager is emerging from the shadow of his collaborator, Nassim Nicholas Taleb, with a big bet inflation will soar.
The 38-year old Mr. Spitznagel managed the Black Swan funds to triple digit returns last year with a bet on volatility. The returns have brought a flood of cash, sending assets for his firm, Universa Investments LP, rising to $6 billion from $300 million.
But, for all the gains, Mr. Spitznagel is still far less known than "Black Swan" author Mr. Taleb, who invests in the funds and helps shape their strategies but doesn't manage the money.
Susan Hall
Mark Spitznagel sees economic stimulus efforts spurring inflation.
"Black swan" alludes to the once-widespread belief that all swans are white -- proved false when European explorers found black swans in Australia. A black-swan event is something extreme and highly unexpected.
Mr. Spitznagel's winning streak now will be tested. Universa is poised to make a huge wager that will reap big rewards if inflation surges. Inflation is on investors' radar thanks to extensive economic stimulus efforts.
"The consequences of the monetary bender the government has put on could be huge," Mr. Spitznagel says.
The new fund, expected to start trading in July, will place bets on options tied to assets expected to benefit from a big leap in prices, including commodities such as corn and crude oil, and options on shares of oil drillers and gold miners. It also will short Treasury bonds, likely to weaken in an inflationary economy.
The inflation bet marks a change for Universa. Typically, Messrs. Spitznagel and Taleb don't have an opinion about the near-term direction of the markets or economy. Rather, they argue, investors tend to underestimate the risks of major market swings. The latest wager is more of a directional bet that regulators' efforts to prop up the financial sector and the broader economy will spark inflation.
Mr. Spitznagel's approach to trading dates to his time as a fledgling pit trader in the early 1990s at the Chicago Board of Trade, where he bought and sold commodities such as cotton and soybeans.
Mr. Spitznagel's mentor, commodity-trading veteran Everett Klipp, trained him to limit losses by having him immediately exit trades as soon as they moved against him.
The notion of quickly folding a hand is alien to many traders who insist the market will come around to their point of view, says Mr. Klipp, 82, who retired several years ago. "You don't argue with the market," he said in an interview.
In the late 1990s, Mr. Spitznagel moved to New York to take courses at New York University, where Mr. Taleb taught. Mr. Taleb was planning to launch a hedge fund in which he would buy far out-of-the-money "put" options that would pay off if the market plunged sharply. Usually it didn't, and the options expired worthless, generating small losses. Options give their owner the right, but not the obligation, to buy or sell a stock at a certain price.
"One thing Mark taught me was that when someone isn't afraid of losing small amounts, they're almost invincible" because they have more staying power, Mr. Taleb said.
The strategy often either looses money or posts flat returns, which can turn off investors. Though the fund Mr. Taleb launched, Empirica Capital, initially made some money, when volatility fell its returns did, too. Burned out by the day-to-day trading grind, Mr. Taleb in 2004 closed down Empirica and concentrated on writing.
Mr. Spitznagel, meanwhile, joined a Morgan Stanley trading unit called Process Driven Trading. Not inclined to meet the bank's request that he sign a stringent "noncompete" agreement, he left Morgan in early 2007 and started to lay the groundwork for Universa.
Universa started trading out of a small office in Santa Monica, Calif., a location Mr. Spitznagel selected partly because of its distance from Wall Street. Mr. Spitznagel doesn't read financial news; rather, he developed software programs that troll options markets for deals.
A small group of mathematically trained traders track the programs, frequently discussing which trades to make with Mr. Spitznagel. Only 14 people work at the firm, though more will be hired for the inflation funds.
From time to time, a Chinese expert in tai chi visits the fund to train Mr. Spitznagel in the martial art, specifically the idea of using an opponent's force again him. Mr. Spitznagel sees similarities between the technique and his trading strategy, he says, since he believes the small losses he takes can eventually give him leverage over traders on the other side of his positions.
Mr. Spitznagel's strategy gained an advantage last year as the turmoil in subprime mortgages turned into a rout. In late September, he was meeting a client outside Chicago while keeping track of the market on his BlackBerry. Investors were on edge as Congress voted on the Treasury Department's $700 billion financial-rescue package.
Suddenly, the market plunged after the House voted it down. Mr. Spitznagel rushed back to his hotel to field calls from investors and manage the fund's positions from a laptop along with traders at Universa's headquarters.
During the next few months, Universa's positions surged in value. Investors piled in, eager for protection as the market spiraled lower. In early 2009, Mr. Spitznagel closed the strategy to new investors.
Now, Universa faces the risk that a quick market recovery eases investors' concerns about another crash. Mr. Spitznagel says that would be a mistake.
"People have been very quick to think that the low is in," he said. "They've lost all perspective on what a bear market can look like and how long it can last."
Write to Scott Patterson at scott.patterson@wsj.com
U.S. Current-Account Deficit Narrowed Last Quarter
By Bob Willis
June 17 (Bloomberg) -- The U.S. current-account deficit
narrowed in the first quarter to $101.5 billion, the least since
2001, reflecting a smaller shortfall in trade of goods.
The gap, the broadest measure of trade because it includes
transfer payments and investment income, was less than forecast and followed a revised $154.9 billion deficit in the previous three months, the Commerce Department said today in Washington.
The current-account deficit is narrowing just as the
government sells record amounts of debt to pay for economic
recovery programs and fund the soaring budget gap. This week’s
first summit of Brazil, China, India and Russia highlights the
risk that emerging powers may diversify away from dollar assets,
potentially lowering their value, as the U.S. tries to tap
overseas investors to fund the twin shortfalls.
“It’s good news from the point of view of less requirement
for external financing,” Brian Bethune, chief U.S. financial
economist at IHS Global Insight in Lexington, Massachusetts,
said before the report. “The lower the trade and current
account deficits, the less capital is needed to finance the
overall deficit.”
Economists forecast a deficit of $85 billion, according to
the median of 37 estimates in a Bloomberg News survey, after an
initially reported $132.8 billion shortfall the prior quarter.
Forecasts ranged from deficits of $74.7 billion to $112 billion.
Foreign earnings on U.S. assets declined to $115 billion
from $146.5 billion in the prior three months.
U.S. income on overseas assets, including wages and
compensation, decreased to $134.3 billion from $167.6 billion.
Income Payments
That left a $19.3 billion surplus on income payments,
compared with a $21.1 billion surplus in the previous quarter.
U.S. government payments to foreigners and other private
transfers abroad decreased to $29.6 billion from $31.5 billion.
A separate Labor Department report today showed the cost of
living in the U.S. rose less than forecast in May, culminating
in the biggest 12-month drop in prices in almost 60 years. The
consumer price index increased 0.1 percent after no change a
month earlier, the department said today in Washington.
The summit this week of the so-called BRIC nations --
Brazil, Russia, India and China -- comes after Brazil, China and
Russia announced plans to shift some foreign reserves into
International Monetary Fund bonds. The heads of those states
called for a “more diversified” global monetary system in a
joint statement released yesterday from the meeting in the
Russian town of Yekaterinburg.
Trade Deficit
The U.S. trade deficit, which accounted for most of the
current-account imbalance, narrowed to $91.2 billion in the
first quarter from $144.5 billion the previous three months. The
figures, which aren’t adjusted for inflation, reflected lower
imported oil costs.
Weaker consumer spending is boosting household savings and
may continue to depress imports, helping to offset increased
government borrowing this year as federal spending soars.
The Congressional Budget Office projects the budget deficit
will reach a record $1.85 trillion this year, boosted by the
Obama administration’s stimulus measures. The budget shortfall
in May widened to $189.7 billion, a record for the month and
compared with a gap of $165.9 billion a year earlier, the
Treasury said June 10. Spending rose 5.8 percent while revenue
fell 5.7 percent.
The current-account gap amounted to 2.9 percent of gross
domestic product, the lowest since 1999, compared with 4.4
percent in the prior quarter. The deficit was 6.6 percent of GDP
during the last quarter of 2005, the highest level since records
began in 1960.
GDP Contribution
Adjusted for prices, which are the numbers used to
calculate GDP, the trade deficit narrowed last quarter,
according to the Commerce Department. Trade added 2.2 percentage
points to economic growth in the first three months of 2009.
International demand for long-term U.S. financial assets
grew more slowly in April than the prior month as China, Japan
and Russia pared demand for Treasuries, underscoring the danger
of U.S. reliance on foreigners to finance the fiscal deficit,
figures from the Treasury Department showed this week.
Total net purchases of long-term equities, notes and bonds
rose a net $11.2 billion, compared with buying of $55.4 billion
in March, the Treasury said today in Washington. International
holdings of Treasuries increased a net $41.9 billion, compared
with the $55.3 billion gain in March. Including bills, the
holdings fell a net $2.6 billion.
June 17 (Bloomberg) -- The U.S. current-account deficit
narrowed in the first quarter to $101.5 billion, the least since
2001, reflecting a smaller shortfall in trade of goods.
The gap, the broadest measure of trade because it includes
transfer payments and investment income, was less than forecast and followed a revised $154.9 billion deficit in the previous three months, the Commerce Department said today in Washington.
The current-account deficit is narrowing just as the
government sells record amounts of debt to pay for economic
recovery programs and fund the soaring budget gap. This week’s
first summit of Brazil, China, India and Russia highlights the
risk that emerging powers may diversify away from dollar assets,
potentially lowering their value, as the U.S. tries to tap
overseas investors to fund the twin shortfalls.
“It’s good news from the point of view of less requirement
for external financing,” Brian Bethune, chief U.S. financial
economist at IHS Global Insight in Lexington, Massachusetts,
said before the report. “The lower the trade and current
account deficits, the less capital is needed to finance the
overall deficit.”
Economists forecast a deficit of $85 billion, according to
the median of 37 estimates in a Bloomberg News survey, after an
initially reported $132.8 billion shortfall the prior quarter.
Forecasts ranged from deficits of $74.7 billion to $112 billion.
Foreign earnings on U.S. assets declined to $115 billion
from $146.5 billion in the prior three months.
U.S. income on overseas assets, including wages and
compensation, decreased to $134.3 billion from $167.6 billion.
Income Payments
That left a $19.3 billion surplus on income payments,
compared with a $21.1 billion surplus in the previous quarter.
U.S. government payments to foreigners and other private
transfers abroad decreased to $29.6 billion from $31.5 billion.
A separate Labor Department report today showed the cost of
living in the U.S. rose less than forecast in May, culminating
in the biggest 12-month drop in prices in almost 60 years. The
consumer price index increased 0.1 percent after no change a
month earlier, the department said today in Washington.
The summit this week of the so-called BRIC nations --
Brazil, Russia, India and China -- comes after Brazil, China and
Russia announced plans to shift some foreign reserves into
International Monetary Fund bonds. The heads of those states
called for a “more diversified” global monetary system in a
joint statement released yesterday from the meeting in the
Russian town of Yekaterinburg.
Trade Deficit
The U.S. trade deficit, which accounted for most of the
current-account imbalance, narrowed to $91.2 billion in the
first quarter from $144.5 billion the previous three months. The
figures, which aren’t adjusted for inflation, reflected lower
imported oil costs.
Weaker consumer spending is boosting household savings and
may continue to depress imports, helping to offset increased
government borrowing this year as federal spending soars.
The Congressional Budget Office projects the budget deficit
will reach a record $1.85 trillion this year, boosted by the
Obama administration’s stimulus measures. The budget shortfall
in May widened to $189.7 billion, a record for the month and
compared with a gap of $165.9 billion a year earlier, the
Treasury said June 10. Spending rose 5.8 percent while revenue
fell 5.7 percent.
The current-account gap amounted to 2.9 percent of gross
domestic product, the lowest since 1999, compared with 4.4
percent in the prior quarter. The deficit was 6.6 percent of GDP
during the last quarter of 2005, the highest level since records
began in 1960.
GDP Contribution
Adjusted for prices, which are the numbers used to
calculate GDP, the trade deficit narrowed last quarter,
according to the Commerce Department. Trade added 2.2 percentage
points to economic growth in the first three months of 2009.
International demand for long-term U.S. financial assets
grew more slowly in April than the prior month as China, Japan
and Russia pared demand for Treasuries, underscoring the danger
of U.S. reliance on foreigners to finance the fiscal deficit,
figures from the Treasury Department showed this week.
Total net purchases of long-term equities, notes and bonds
rose a net $11.2 billion, compared with buying of $55.4 billion
in March, the Treasury said today in Washington. International
holdings of Treasuries increased a net $41.9 billion, compared
with the $55.3 billion gain in March. Including bills, the
holdings fell a net $2.6 billion.
Tuesday, June 16, 2009
Morgan Stanley Offers Investors in Hedge Funds a New Option
By AARON LUCCHETTI
Morgan Stanley is planning more changes in its prime-brokerage division to lure back some of the hedge-fund clients that left the firm last year.
The New York firm plans to announce as soon as Wednesday that hedge-fund clients will be allowed to hold part of their assets in Morgan Stanley Trust National Association, a trust company owned by Morgan Stanley. Previously, such assets were held in the firm's brokerage units.
The move is meant to reassure clients concerned about a potential repeat of the panicked market conditions last fall, when many hedge funds feared for the safety of their money after the collapse of Lehman Brothers Holdings Inc.
More
Morgan Stanley to Repay TARP While Morgan Stanley's bond and stock prices indicate that investors have grown more confident about the firm, the new option for hedge-fund clients will offer "a belt-and-suspenders approach" for those who still are concerned about protecting their assets, said Rich Portogallo, Morgan Stanley's head of institutional clients and services.
The company is expected to charge additional fees for clients that leave their securities in the trust company.
In May, hedge funds soaked up net cash inflows for the first time in 10 months, Eurekahedge said Tuesday. May also delivered the best hedge-fund performance in years, according to various fund trackers. Hedge Fund Research Inc. also said the pace at which funds are closing has slowed, with 376 funds liquidating in the first quarter of the year, less than half the number of closures in the final quarter of 2008.
Morgan Stanley's planned announcement comes amid a wider effort by many hedge funds to make sure their assets are safe during market tumult. After Lehman's bankruptcy filing last September, some found they couldn't get their money back from that firm.
Other banks offer services that are similar to Morgan Stanley's, but the company's hedge-fund efforts are being closely watched because the firm lost a significant chunk of that business last year and has made personnel changes in its prime brokerage unit. The firm has brought many clients back, but balances are still down from the peak last year.
Securities held in Morgan's trust bank won't be federally insured like deposits, but could be viewed as safer because they are housed separately from the firm's broker-deal operation. Morgan Stanley Trust National Association, regulated by the Office of the Comptroller of the Currency, has 52 employees and about $14 million in total assets, according to a regulatory filing.
—Gregory Meyer contributed to this article.
Write to Aaron Lucchetti at aaron.lucchetti@wsj.com
Morgan Stanley is planning more changes in its prime-brokerage division to lure back some of the hedge-fund clients that left the firm last year.
The New York firm plans to announce as soon as Wednesday that hedge-fund clients will be allowed to hold part of their assets in Morgan Stanley Trust National Association, a trust company owned by Morgan Stanley. Previously, such assets were held in the firm's brokerage units.
The move is meant to reassure clients concerned about a potential repeat of the panicked market conditions last fall, when many hedge funds feared for the safety of their money after the collapse of Lehman Brothers Holdings Inc.
More
Morgan Stanley to Repay TARP While Morgan Stanley's bond and stock prices indicate that investors have grown more confident about the firm, the new option for hedge-fund clients will offer "a belt-and-suspenders approach" for those who still are concerned about protecting their assets, said Rich Portogallo, Morgan Stanley's head of institutional clients and services.
The company is expected to charge additional fees for clients that leave their securities in the trust company.
In May, hedge funds soaked up net cash inflows for the first time in 10 months, Eurekahedge said Tuesday. May also delivered the best hedge-fund performance in years, according to various fund trackers. Hedge Fund Research Inc. also said the pace at which funds are closing has slowed, with 376 funds liquidating in the first quarter of the year, less than half the number of closures in the final quarter of 2008.
Morgan Stanley's planned announcement comes amid a wider effort by many hedge funds to make sure their assets are safe during market tumult. After Lehman's bankruptcy filing last September, some found they couldn't get their money back from that firm.
Other banks offer services that are similar to Morgan Stanley's, but the company's hedge-fund efforts are being closely watched because the firm lost a significant chunk of that business last year and has made personnel changes in its prime brokerage unit. The firm has brought many clients back, but balances are still down from the peak last year.
Securities held in Morgan's trust bank won't be federally insured like deposits, but could be viewed as safer because they are housed separately from the firm's broker-deal operation. Morgan Stanley Trust National Association, regulated by the Office of the Comptroller of the Currency, has 52 employees and about $14 million in total assets, according to a regulatory filing.
—Gregory Meyer contributed to this article.
Write to Aaron Lucchetti at aaron.lucchetti@wsj.com
Critic Disappointed At Health Care Proposal
President Obama is pushing to overhaul the nation's health care system, but doctors, hospital officials and others are raising sharp concerns over his call for a government-run insurance plan to compete with private plans.
Peter Orszag, director of the White House's Office of Management and Budget, defends the plan, telling NPR's Michele Norris that it will put the U.S. "on a path to eliminating the number of uninsured people in the United States."
Orszag says evidence suggests that many insurance markets lack adequate competition, and the goal of the public plan is to expand choice, introduce more competition and drive down premium costs.
"Our goal here is not to force doctors and hospitals to do things that they don't want to do, but rather to create a plan that we think that they'll want to participate in, and that beneficiaries will find helpful also in terms of having more choices available," he says.
One challenge the administration faces, however, is that in areas such as Howard County, Md., which offers relatively low-cost health coverage to its residents, many don't enroll. Orszag says no one would be required to participate in a public plan, but "there are proposals that the president is open to — to have some sort of personal responsibility where you have to carry insurance just like you do when you drive a car. But you could purchase that insurance through a health exchange where the public plan would be one of many options."
Concerns From Hospitals
One aspect of the proposal that has come under fire is a proposed $200 billion cut in federal payments to hospitals. Hospital officials say that will result in cuts in services to the people who need it most.
But Orszag says that, for example, under the reimbursement system known as disproportionate share payments, government funding is provided to hospitals in large part to help meet the cost of caring for the uninsured.
"Our argument is that as the number of uninsured goes down ... the hospitals would in a sense be double-paid if the number of uninsured people declines significantly and they were still receiving payments to meet the cost of the uninsured," he says. "So we scale those back, and we would also target those payments more efficiently toward the hospitals that are disproportionately serving the remaining uninsured."
Rich Umbdenstock, president and CEO of the American Hospital Association, tells NPR's Robert Siegel that the hospitals have accepted "in principle" that reimbursements from Washington will decline as the number of insured patients rise at those institutions. But, he says, too many questions remain.
"How soon will that coverage kick in? At what payment levels? Across what proportion of the uninsured population?" he asks. "Even by the best estimates, right now, people are saying that it looks like some of the plans that are out there can cover maybe a third, maybe, at the high end, two-thirds of the population. That still leaves a lot of people uncovered. It still leaves a lot of people on the Medicaid program, and it still leaves a lot of people who are undocumented immigrants and so on. That need's not going to go away overnight."
Orszag says opposition to the health care overhaul is inevitable. "We're not going to transform a $2 trillion sector of the economy without some jostling occurring and without some objections being raised or some concerns being raised," he says. "That's natural."
And Umbdenstock says all the stakeholders in the health care system have to examine what they can do now to cut costs.
"You have to look at cuts in the context of a complete plan for reform. And our elements in reform include the important element of affordability," Umbdenstock says. "But also we have to think about coverage. We have to think about quality."
Peter Orszag, director of the White House's Office of Management and Budget, defends the plan, telling NPR's Michele Norris that it will put the U.S. "on a path to eliminating the number of uninsured people in the United States."
Orszag says evidence suggests that many insurance markets lack adequate competition, and the goal of the public plan is to expand choice, introduce more competition and drive down premium costs.
"Our goal here is not to force doctors and hospitals to do things that they don't want to do, but rather to create a plan that we think that they'll want to participate in, and that beneficiaries will find helpful also in terms of having more choices available," he says.
One challenge the administration faces, however, is that in areas such as Howard County, Md., which offers relatively low-cost health coverage to its residents, many don't enroll. Orszag says no one would be required to participate in a public plan, but "there are proposals that the president is open to — to have some sort of personal responsibility where you have to carry insurance just like you do when you drive a car. But you could purchase that insurance through a health exchange where the public plan would be one of many options."
Concerns From Hospitals
One aspect of the proposal that has come under fire is a proposed $200 billion cut in federal payments to hospitals. Hospital officials say that will result in cuts in services to the people who need it most.
But Orszag says that, for example, under the reimbursement system known as disproportionate share payments, government funding is provided to hospitals in large part to help meet the cost of caring for the uninsured.
"Our argument is that as the number of uninsured goes down ... the hospitals would in a sense be double-paid if the number of uninsured people declines significantly and they were still receiving payments to meet the cost of the uninsured," he says. "So we scale those back, and we would also target those payments more efficiently toward the hospitals that are disproportionately serving the remaining uninsured."
Rich Umbdenstock, president and CEO of the American Hospital Association, tells NPR's Robert Siegel that the hospitals have accepted "in principle" that reimbursements from Washington will decline as the number of insured patients rise at those institutions. But, he says, too many questions remain.
"How soon will that coverage kick in? At what payment levels? Across what proportion of the uninsured population?" he asks. "Even by the best estimates, right now, people are saying that it looks like some of the plans that are out there can cover maybe a third, maybe, at the high end, two-thirds of the population. That still leaves a lot of people uncovered. It still leaves a lot of people on the Medicaid program, and it still leaves a lot of people who are undocumented immigrants and so on. That need's not going to go away overnight."
Orszag says opposition to the health care overhaul is inevitable. "We're not going to transform a $2 trillion sector of the economy without some jostling occurring and without some objections being raised or some concerns being raised," he says. "That's natural."
And Umbdenstock says all the stakeholders in the health care system have to examine what they can do now to cut costs.
"You have to look at cuts in the context of a complete plan for reform. And our elements in reform include the important element of affordability," Umbdenstock says. "But also we have to think about coverage. We have to think about quality."
Housing Construction Up 17.2 Percent In May
--Housing construction up 17.2%
--industrial production tumbled 1.1%
Construction of new homes jumped in May by the largest amount in three months, providing an encouraging sign that the nation's deep housing recession was beginning to bottom out. But industrial production tumbled a larger-than-expected 1.1 percent — the seventh consecutive monthly drop. Meanwhile, wholesale inflation rose less than expected last month.
Construction of new homes and apartments jumped 17.2 percent last month to a seasonally adjusted annual rate of 532,000 units, the Commerce Department said Tuesday. That topped the 500,000-unit pace that economists had expected and came after construction had fallen in April to a record low of 454,000 units.
In another encouraging sign, applications for building permits, seen as a good indicator of future activity, rose by 4 percent in May to an annual rate of 518,000 units.
The better-than-expected rebound in construction was the latest sign that the prolonged slump in housing is coming to an end, which would be good news for the broader economy.
The 17.2 percent rise in housing construction for May still left activity 45.2 percent below where it was a year ago.
The May increase reflected a 7.5 percent rise in construction of single-family homes, the third consecutive increase in this critical segment of the market.
Construction of multifamily units was up 61.7 percent in May to an annual rate of 131,000 units.
Industrial Production Tumbles
But even as housing activity picked up, industrial production fell 1.1 percent in May as the recession crimped demand for a wide range of manufactured goods including cars, machinery and household appliances.
The Federal Reserve's report on Tuesday showed production at the nation's factories, mines and utilities has fallen for seven straight months. Output also turned out to be a bit weaker — a 0.7 percent decline- in April than the Fed initially reported.
Industrial companies idled more of their plants and equipment. The overall operating rate fell to 68.3 percent in May, a record low dating to 1967. The previous low was set in April, when operating capacity dropped to a revised reading of 69, slightly weaker than first reported.
Production in the manufacturing sector fell 1 percent in May. That followed a revised drop of 0.6 percent in April, double what the Fed initially estimated. Output in mining fell 2.1 percent in May, after decreasing 3.2 percent the previous month. Production at utilities fell 1.4 percent in May, erasing a 0.7 percent increase in April.
Production of autos and parts plunged 7.9 percent, following a 1.2 percent decline in April. Machinery production dropped 3.4 percent, after a 2.5 percent decline.
Wholesale Inflation Up Modestly
Meanwhile, a separate report showed that wholesale prices rose less than expected in May as a large jump in the price of gasoline offset a drop in food costs.
The Labor Department said Tuesday that the Producer Price Index increased by a seasonally adjusted 0.2 percent from April. That's below analysts' expectations of a 0.6 percent rise.
Despite the increase, wholesale prices fell 5 percent in the past 12 months. That's the largest annual drop in almost 60 years.
Excluding volatile food and energy prices, the core PPI dropped 0.1 percent in May, also below analysts' forecasts of a 0.1 percent rise.
Falling prices can raise fears about deflation, a destabilizing period of extended declines. But most economists believe that efforts by the Federal Reserve to combat the recession will prevent that from happening.
A 2.9 percent rise in energy prices, including a 13.9 percent jump in the cost of gasoline, drove the May increase. Pump prices reached about $2.50 a gallon by the end of last month.
--industrial production tumbled 1.1%
Construction of new homes jumped in May by the largest amount in three months, providing an encouraging sign that the nation's deep housing recession was beginning to bottom out. But industrial production tumbled a larger-than-expected 1.1 percent — the seventh consecutive monthly drop. Meanwhile, wholesale inflation rose less than expected last month.
Construction of new homes and apartments jumped 17.2 percent last month to a seasonally adjusted annual rate of 532,000 units, the Commerce Department said Tuesday. That topped the 500,000-unit pace that economists had expected and came after construction had fallen in April to a record low of 454,000 units.
In another encouraging sign, applications for building permits, seen as a good indicator of future activity, rose by 4 percent in May to an annual rate of 518,000 units.
The better-than-expected rebound in construction was the latest sign that the prolonged slump in housing is coming to an end, which would be good news for the broader economy.
The 17.2 percent rise in housing construction for May still left activity 45.2 percent below where it was a year ago.
The May increase reflected a 7.5 percent rise in construction of single-family homes, the third consecutive increase in this critical segment of the market.
Construction of multifamily units was up 61.7 percent in May to an annual rate of 131,000 units.
Industrial Production Tumbles
But even as housing activity picked up, industrial production fell 1.1 percent in May as the recession crimped demand for a wide range of manufactured goods including cars, machinery and household appliances.
The Federal Reserve's report on Tuesday showed production at the nation's factories, mines and utilities has fallen for seven straight months. Output also turned out to be a bit weaker — a 0.7 percent decline- in April than the Fed initially reported.
Industrial companies idled more of their plants and equipment. The overall operating rate fell to 68.3 percent in May, a record low dating to 1967. The previous low was set in April, when operating capacity dropped to a revised reading of 69, slightly weaker than first reported.
Production in the manufacturing sector fell 1 percent in May. That followed a revised drop of 0.6 percent in April, double what the Fed initially estimated. Output in mining fell 2.1 percent in May, after decreasing 3.2 percent the previous month. Production at utilities fell 1.4 percent in May, erasing a 0.7 percent increase in April.
Production of autos and parts plunged 7.9 percent, following a 1.2 percent decline in April. Machinery production dropped 3.4 percent, after a 2.5 percent decline.
Wholesale Inflation Up Modestly
Meanwhile, a separate report showed that wholesale prices rose less than expected in May as a large jump in the price of gasoline offset a drop in food costs.
The Labor Department said Tuesday that the Producer Price Index increased by a seasonally adjusted 0.2 percent from April. That's below analysts' expectations of a 0.6 percent rise.
Despite the increase, wholesale prices fell 5 percent in the past 12 months. That's the largest annual drop in almost 60 years.
Excluding volatile food and energy prices, the core PPI dropped 0.1 percent in May, also below analysts' forecasts of a 0.1 percent rise.
Falling prices can raise fears about deflation, a destabilizing period of extended declines. But most economists believe that efforts by the Federal Reserve to combat the recession will prevent that from happening.
A 2.9 percent rise in energy prices, including a 13.9 percent jump in the cost of gasoline, drove the May increase. Pump prices reached about $2.50 a gallon by the end of last month.
Investors Shed U.S. Assets
By RIVA FROYMOVICH and DEBORAH LYNN BLUMBERG
Foreign and U.S. investors moved capital out of U.S. assets in April, with much of the outflows concentrated in short-term securities, such as Treasury bills.
The switch in capital flows reflect investors' greater appetite for risk. Foreign investors sold dollar-denominated assets they had bought to shelter their portfolios from turbulent markets. U.S. investors, meanwhile, bought more foreign securities.
Net outflows in April, including short-term securities and changes in bank deposits, totaled $53.2 billion, according to the Treasurys International Capital report, compared with the inflows of $25 billion in March.
"With the global economy pulling back from the perceived precipice in early 2009 ... the April Treasury TIC report for the most part reflects these rapid changes in investor preferences," said Brian Bethune, chief U.S. financial economist at IHS Global Insight.
Private-sector investors liquidated $32.4 billion of Treasury bills in April. In addition, three large official purchasers of Treasurys -- China, Japan and Russia -- all trimmed their holdings of U.S. debt. In total, government entities sold $12.1 billion of Treasury bills.
And there likely is more to come. "I would expect that the May data will show much larger liquidations of Treasury bills," said Alan Ruskin, head of international currency for RBS.
Some of the funds were shifted into longer-term U.S. government debt, the data show, with private investors from overseas buying a net $24.8 billion in notes and bonds, and foreign official institutions, including central banks, buying a net $17.1 billion.
Foreign investors continued to shun debt issued by housing-finance companies Fannie Mae and Freddie Mac, selling $2.5 billion in April after $15.6 billion in sales in March. They also sold $9.7 billion in corporate debt after purchases of $3.5 billion in the previous month.
Treasury markets shrugged off the data and posted gains, focusing on the losses in the stock market and two coming rounds of Treasury purchases by the Federal Reserve this week.
Late Monday in New York, the 10-year note rose 18/32 point, or $5.625 for every $1,000 invested, at 95 5/32, to yield 3.713%, down from 3.783% late Friday, as yields move inversely to prices.
Enthusiasm for an improving economy also was tempered by softer data on regional manufacturing and housing for June, underscored by a note of caution from Treasury Secretary Timothy Geithner on Monday. He said the nation is "still facing enormous challenges," and unemployment is likely to rise.
The threat of sales by large foreign holders of U.S. government debt also dissipated over the weekend, as Russia calmed fears over its stance on Treasurys and the dollar's status as reserve currency. Mr. Geithner on Monday reiterated that China has "a lot of confidence" in U.S. economic fundamentals.
Foreign and U.S. investors moved capital out of U.S. assets in April, with much of the outflows concentrated in short-term securities, such as Treasury bills.
The switch in capital flows reflect investors' greater appetite for risk. Foreign investors sold dollar-denominated assets they had bought to shelter their portfolios from turbulent markets. U.S. investors, meanwhile, bought more foreign securities.
Net outflows in April, including short-term securities and changes in bank deposits, totaled $53.2 billion, according to the Treasurys International Capital report, compared with the inflows of $25 billion in March.
"With the global economy pulling back from the perceived precipice in early 2009 ... the April Treasury TIC report for the most part reflects these rapid changes in investor preferences," said Brian Bethune, chief U.S. financial economist at IHS Global Insight.
Private-sector investors liquidated $32.4 billion of Treasury bills in April. In addition, three large official purchasers of Treasurys -- China, Japan and Russia -- all trimmed their holdings of U.S. debt. In total, government entities sold $12.1 billion of Treasury bills.
And there likely is more to come. "I would expect that the May data will show much larger liquidations of Treasury bills," said Alan Ruskin, head of international currency for RBS.
Some of the funds were shifted into longer-term U.S. government debt, the data show, with private investors from overseas buying a net $24.8 billion in notes and bonds, and foreign official institutions, including central banks, buying a net $17.1 billion.
Foreign investors continued to shun debt issued by housing-finance companies Fannie Mae and Freddie Mac, selling $2.5 billion in April after $15.6 billion in sales in March. They also sold $9.7 billion in corporate debt after purchases of $3.5 billion in the previous month.
Treasury markets shrugged off the data and posted gains, focusing on the losses in the stock market and two coming rounds of Treasury purchases by the Federal Reserve this week.
Late Monday in New York, the 10-year note rose 18/32 point, or $5.625 for every $1,000 invested, at 95 5/32, to yield 3.713%, down from 3.783% late Friday, as yields move inversely to prices.
Enthusiasm for an improving economy also was tempered by softer data on regional manufacturing and housing for June, underscored by a note of caution from Treasury Secretary Timothy Geithner on Monday. He said the nation is "still facing enormous challenges," and unemployment is likely to rise.
The threat of sales by large foreign holders of U.S. government debt also dissipated over the weekend, as Russia calmed fears over its stance on Treasurys and the dollar's status as reserve currency. Mr. Geithner on Monday reiterated that China has "a lot of confidence" in U.S. economic fundamentals.
Debt Fears Abate, With No Tiers Shed
By RICHARD BARLEY
Tier 1 bank debt is back from the dead -- the latest evidence of a remarkable risk-appetite recovery. Three new deals have been announced in June, from the Netherlands' Rabobank Nederland, France's Credit Agricole and the U.K.'s Standard Chartered.
Months ago, the very future of Tier 1 debt was in doubt. But the revival doesn't mean it will enjoy a long, fulfilling life.
Tier 1 bonds -- which combine features of debt and equity, including the ability to skip interest payments and defer principal repayment -- were important sources of bank capital. The iBoxx bond indexes contain €185 billion ($259 billion) worth of Tier 1 debt. Banks liked them because they were cheaper than pure equity, enabling banks to report higher returns.
But the crisis froze the market. Investors feared banks, particularly if nationalized, would defer payments or leave debt outstanding in perpetuity. Euro Tier 1 bond yields peaked 37 percentage points above government debt in March.
The recent recovery reflects new realities. Triple-A-rated Rabobank paid 11% recently, compared with about 5.3% on one pre-crisis deal. That looks high, but interest is tax-deductible, reducing the true cost.
And this may be a false dawn. Policy makers rightly question whether these structures are truly loss-bearing and should count as capital. The U.K.'s Northern Rock, for example, has continued paying interest on Tier 1 bonds since nationalization.
The Bank of England's Paul Tucker last week called for a wholesale conversion of subordinated bonds into equity or senior debt. But new rules across Europe look some way off. While the window is open, expect more banks to jump through it.
Write to Richard Barley at richard.barley@dowjones.com
Tier 1 bank debt is back from the dead -- the latest evidence of a remarkable risk-appetite recovery. Three new deals have been announced in June, from the Netherlands' Rabobank Nederland, France's Credit Agricole and the U.K.'s Standard Chartered.
Months ago, the very future of Tier 1 debt was in doubt. But the revival doesn't mean it will enjoy a long, fulfilling life.
Tier 1 bonds -- which combine features of debt and equity, including the ability to skip interest payments and defer principal repayment -- were important sources of bank capital. The iBoxx bond indexes contain €185 billion ($259 billion) worth of Tier 1 debt. Banks liked them because they were cheaper than pure equity, enabling banks to report higher returns.
But the crisis froze the market. Investors feared banks, particularly if nationalized, would defer payments or leave debt outstanding in perpetuity. Euro Tier 1 bond yields peaked 37 percentage points above government debt in March.
The recent recovery reflects new realities. Triple-A-rated Rabobank paid 11% recently, compared with about 5.3% on one pre-crisis deal. That looks high, but interest is tax-deductible, reducing the true cost.
And this may be a false dawn. Policy makers rightly question whether these structures are truly loss-bearing and should count as capital. The U.K.'s Northern Rock, for example, has continued paying interest on Tier 1 bonds since nationalization.
The Bank of England's Paul Tucker last week called for a wholesale conversion of subordinated bonds into equity or senior debt. But new rules across Europe look some way off. While the window is open, expect more banks to jump through it.
Write to Richard Barley at richard.barley@dowjones.com
Defaults Pose Latest Snag In Islamic-Bond Market
By STEPHEN FIDLER
LONDON -- The once-booming market for Islamic-friendly bonds, having suffered a contraction amid the credit crisis, now faces a new challenge: default.
The fledgling market in recent months experienced its first two defaults, and they aren't expected to be the last as issuers like Saad Group hit financial difficulties. This is taking investors and courts into uncharted territory as they seek to apply Western laws to bonds that were designed to comply with Islamic law, or Shariah.
Agence France-Presse/Getty Images
RELIGION AND FINANCE: Indonesian women outside the Sharia Finance Exhibition in Jakarta in February.
In what could prove to be a test case, a bankruptcy judge in Louisiana is deciding the fate of holders of bonds tied to bankrupt energy firm East Cameron Partners LP, which in 2006 became the first U.S. company to issue the most popular type of Islamic-friendly instrument, known as a sukuk. One question: whether the bondholders actually own a portion of the company's oil and gas.
As such cases work their way through courts, or are resolved without court intervention, "they may give some guidance to investors on the default of sukuk and how this would be resolved," says Mohamed Damak, an analyst with ratings firm Standard & Poor's in Paris.
Sukuk bonds get around the Islamic ban on speculation and paying interest by using devices such as sale-repurchase deals.
Although based on centuries-old religious law, the sukuk market has been a 21st-century phenomenon. More than $115 billion of such bonds have been issued since the turn of the century, buoyed by money from oil-rich Middle Eastern investors and non-Islamic players such as hedge funds, which accounted for as much as 80% of some issues.
In 2007 alone, issuers of sukuk raised some $46.6 billion, according to figures from the London-based Islamic Finance Information Service, or IFIS.
Then, says Muneer Khan, Dubai-based partner with the Simmons & Simmons law firm, there was "a double whammy for the sukuk market." Even as the global financial crisis and falling oil prices took a severe toll, investors had to digest the implications of a "back to basics" movement among some scholars in Shariah law.
The recent defaults are only the latest twist for a market that has seen its fair share of growing pains over the past two years.
In 2007, respected Pakistani scholar Muhammad Taqi Usmani delivered a bombshell, suggesting that the most popular type of sukuk structures, responsible for up to 85% of issues, were unlawful according to Islam.
The problem: They offered partial or total guarantees of repayments or of annual distributions, which ran counter to the Islamic principle that parties to a financial transaction must share in the risks and rewards attached to it. Last year, the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions formally ruled such structures weren't Shariah-compliant.
The ruling wasn't retrospective, so Muslims didn't have to unload past investments. But it had a chilling effect: In all of 2008, only $15.8 billion in sukuk were issued, according to IFIS. Mr. Taqi Usmani "didn't realize how much his views mattered," says Dawood Ahmedji, director of Islamic Finance at Deloitte LLP.
Then came the defaults. In October, East Cameron Gas Co. filed for bankruptcy protection after its offshore Louisiana oil and gas wells failed to yield the expected returns, partly because of hurricane damage. Some $167.8 million of sukuk bonds were affected. And last month, Investment Dar Co., a Kuwaiti investment company that owns a 50% stake in luxury-car maker Aston Martin Lagonda Ltd., missed a payment on a $100 million sukuk, becoming the first company from the Middle East to default on Islamic bonds.
Such defaults have the potential to be complicated. Many bonds were issued under Western law, which can conflict with Islamic principles. In a 2004 case relating to the enforceability of a contract, the U.K. Appeals Court ruled that when Shariah and English law conflict, English law takes precedence.
The structure of sukuk bonds can invite challenges and delays as Western bankruptcy judges accustomed to traditional bonds try to figure out where sukuk holders belong in the line of creditors, and even whether they are creditors or owners.
In the East Cameron case, for example, the company argued that there had been no real transfer of ownership of production revenues, known as royalties, into a "special-purpose vehicle" formed to issue the sukuk. Instead, they claimed the transaction was really a loan secured on those royalties. That would mean the sukuk holders would have to share the royalties with other creditors in the event of a liquidation.
The bankruptcy judge, Robert Summerhays, has so far rejected this contention.
He ruled, according to court records, that "holders invested in the sukuk certificates in reliance of the characterization of the transfer of the royalty interest as a true sale." He gave East Cameron leave to find further arguments to support its case, but if he maintains his position, the sukuk holders' rights will be strengthened.
Mr. Damak says the sukuk market has the potential to rebound once such issues are resolved. He estimates there are more than $50 billion of sukuk in the pipeline awaiting the right market opportunity.
The market has in fact managed to come back modestly -- but only for higher quality issuers. So far this year, more than $7.6 billion of sukuk have been issued, IFIS data show. Almost all this year's fund-raisers have been governments or government-related, the overwhelming majority from southeast Asian countries such as Indonesia. The Middle Eastern market that drove the pre-2007 boom has also sprung into life this month with a $500 million issue for the government of Bahrain, which was boosted to $750 million because of strong demand.
According to a 2007 study by economists from the International Monetary Fund, sukuk have delivered lower returns to investors than conventional bonds and are more often illiquid, meaning they are hard to buy and sell in the secondary market.
Write to Stephen Fidler at stephen.fidler@wsj.com
LONDON -- The once-booming market for Islamic-friendly bonds, having suffered a contraction amid the credit crisis, now faces a new challenge: default.
The fledgling market in recent months experienced its first two defaults, and they aren't expected to be the last as issuers like Saad Group hit financial difficulties. This is taking investors and courts into uncharted territory as they seek to apply Western laws to bonds that were designed to comply with Islamic law, or Shariah.
Agence France-Presse/Getty Images
RELIGION AND FINANCE: Indonesian women outside the Sharia Finance Exhibition in Jakarta in February.
In what could prove to be a test case, a bankruptcy judge in Louisiana is deciding the fate of holders of bonds tied to bankrupt energy firm East Cameron Partners LP, which in 2006 became the first U.S. company to issue the most popular type of Islamic-friendly instrument, known as a sukuk. One question: whether the bondholders actually own a portion of the company's oil and gas.
As such cases work their way through courts, or are resolved without court intervention, "they may give some guidance to investors on the default of sukuk and how this would be resolved," says Mohamed Damak, an analyst with ratings firm Standard & Poor's in Paris.
Sukuk bonds get around the Islamic ban on speculation and paying interest by using devices such as sale-repurchase deals.
Although based on centuries-old religious law, the sukuk market has been a 21st-century phenomenon. More than $115 billion of such bonds have been issued since the turn of the century, buoyed by money from oil-rich Middle Eastern investors and non-Islamic players such as hedge funds, which accounted for as much as 80% of some issues.
In 2007 alone, issuers of sukuk raised some $46.6 billion, according to figures from the London-based Islamic Finance Information Service, or IFIS.
Then, says Muneer Khan, Dubai-based partner with the Simmons & Simmons law firm, there was "a double whammy for the sukuk market." Even as the global financial crisis and falling oil prices took a severe toll, investors had to digest the implications of a "back to basics" movement among some scholars in Shariah law.
The recent defaults are only the latest twist for a market that has seen its fair share of growing pains over the past two years.
In 2007, respected Pakistani scholar Muhammad Taqi Usmani delivered a bombshell, suggesting that the most popular type of sukuk structures, responsible for up to 85% of issues, were unlawful according to Islam.
The problem: They offered partial or total guarantees of repayments or of annual distributions, which ran counter to the Islamic principle that parties to a financial transaction must share in the risks and rewards attached to it. Last year, the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions formally ruled such structures weren't Shariah-compliant.
The ruling wasn't retrospective, so Muslims didn't have to unload past investments. But it had a chilling effect: In all of 2008, only $15.8 billion in sukuk were issued, according to IFIS. Mr. Taqi Usmani "didn't realize how much his views mattered," says Dawood Ahmedji, director of Islamic Finance at Deloitte LLP.
Then came the defaults. In October, East Cameron Gas Co. filed for bankruptcy protection after its offshore Louisiana oil and gas wells failed to yield the expected returns, partly because of hurricane damage. Some $167.8 million of sukuk bonds were affected. And last month, Investment Dar Co., a Kuwaiti investment company that owns a 50% stake in luxury-car maker Aston Martin Lagonda Ltd., missed a payment on a $100 million sukuk, becoming the first company from the Middle East to default on Islamic bonds.
Such defaults have the potential to be complicated. Many bonds were issued under Western law, which can conflict with Islamic principles. In a 2004 case relating to the enforceability of a contract, the U.K. Appeals Court ruled that when Shariah and English law conflict, English law takes precedence.
The structure of sukuk bonds can invite challenges and delays as Western bankruptcy judges accustomed to traditional bonds try to figure out where sukuk holders belong in the line of creditors, and even whether they are creditors or owners.
In the East Cameron case, for example, the company argued that there had been no real transfer of ownership of production revenues, known as royalties, into a "special-purpose vehicle" formed to issue the sukuk. Instead, they claimed the transaction was really a loan secured on those royalties. That would mean the sukuk holders would have to share the royalties with other creditors in the event of a liquidation.
The bankruptcy judge, Robert Summerhays, has so far rejected this contention.
He ruled, according to court records, that "holders invested in the sukuk certificates in reliance of the characterization of the transfer of the royalty interest as a true sale." He gave East Cameron leave to find further arguments to support its case, but if he maintains his position, the sukuk holders' rights will be strengthened.
Mr. Damak says the sukuk market has the potential to rebound once such issues are resolved. He estimates there are more than $50 billion of sukuk in the pipeline awaiting the right market opportunity.
The market has in fact managed to come back modestly -- but only for higher quality issuers. So far this year, more than $7.6 billion of sukuk have been issued, IFIS data show. Almost all this year's fund-raisers have been governments or government-related, the overwhelming majority from southeast Asian countries such as Indonesia. The Middle Eastern market that drove the pre-2007 boom has also sprung into life this month with a $500 million issue for the government of Bahrain, which was boosted to $750 million because of strong demand.
According to a 2007 study by economists from the International Monetary Fund, sukuk have delivered lower returns to investors than conventional bonds and are more often illiquid, meaning they are hard to buy and sell in the secondary market.
Write to Stephen Fidler at stephen.fidler@wsj.com
Hold on tight for a bumpy ride to the 'new normal'
By Mohammad El-Erian
Published: June 16 2009 03:00 Last updated: June 16 2009 03:00
Most investment professionals I meet are no longer hesitant to talk of their experiences in 2008. The phenomenon is reminiscent of a group that, having survived a near-death experience, now feels the need (and has the confidence) to talk about it.
This is understandable. Last year's shocks have given way to a greater sense of stability in financial markets. Yet it would be wrong to conclude that we are returning to "business as usual". The next few quarters will be about the aftershocks, driven not by a financial system in disarray but by the lagged reactions of the real economy, the political system and the financial services industry.
At its most fundamental level, 2009 is about the interaction of three factors: the healing of financial markets, second-round economic and political effects and partial reconfiguration of the longer-term landscape. We face the challenge of navigating a bumpy journey to a "new normal". The answers to four basic questions are the key to addressing this challenge successfully.
First, how far will the balance shift from markets to governments? Industrial nations' governments are getting more involved in modes of production, exchange and distribution - see the US, long committed to minimum state involvement. The drivers of more government involvement in markets are primarily non-commercial. Entry is dictated by a desire to offset market failures and exit is often delayed by the lobbying of those favourably affected by such interventions.
The risk of the latter is higher when market interventions lack a clear notion of when and how governments will exit, as well as delays in addressing unintended consequences. Business leaders now need to design strategies that recognise a more influential public policy risk factor.
Second, how will governments finance their growing involvement in the economy? Markets are increasingly worried about the longer-term cost of the rise in public sector borrowing. Given the huge numbers, policymakers must find a way to upgrade liability management approaches.
They must also signal their intention credibly to return to longer-term fiscal sustainability through the generation of meaningful primary budgetary surpluses.
Neither is easy. Yet the impact is far from straightforward. For example, we also have the Federal Reserve buying Treasuries, agencies and mortgages in the secondary markets. This means that with the Treasury as seller, we have two non-commercial players on different sides of the bid/offer in benchmark markets that also influence the levered financing of other instruments further down the risk spectrum.
Third, to what extent will this alter the role of the US in the global economy? The US supplies two critical global public goods: the reserve currency and deep and predictable financial markets. The rent it collects has allowed the US to contain funding costs and gain macro-policy flexibility.
The greater the questioning of these public goods, the more investors will reduce their large exposure to US assets. As such, the US may find it more difficult to operate like a large closed economy at a time when it has become a more open economy that is losing its size advantage gradually.
Fourth, how far will governments go in de-risking the financial system? The economic crisis of 2009, characterised by high and rising unemployment, is a result of the financial crisis of 2008. Expect even louder reactions from politicians, especially those facing elections in the next two years.
The politically driven de-risking reduces the credit that lubricates economic activity. While limiting systemic risk, this lowers the potential rate of growth and fuels significant consolidation in the financial services sector.
These four issues are consequential and call for a re-tooling of mindsets, institutions and approaches. Those who recognise this will fare better during a year that promises both the best and worst of times for businesses.
Published: June 16 2009 03:00 Last updated: June 16 2009 03:00
Most investment professionals I meet are no longer hesitant to talk of their experiences in 2008. The phenomenon is reminiscent of a group that, having survived a near-death experience, now feels the need (and has the confidence) to talk about it.
This is understandable. Last year's shocks have given way to a greater sense of stability in financial markets. Yet it would be wrong to conclude that we are returning to "business as usual". The next few quarters will be about the aftershocks, driven not by a financial system in disarray but by the lagged reactions of the real economy, the political system and the financial services industry.
At its most fundamental level, 2009 is about the interaction of three factors: the healing of financial markets, second-round economic and political effects and partial reconfiguration of the longer-term landscape. We face the challenge of navigating a bumpy journey to a "new normal". The answers to four basic questions are the key to addressing this challenge successfully.
First, how far will the balance shift from markets to governments? Industrial nations' governments are getting more involved in modes of production, exchange and distribution - see the US, long committed to minimum state involvement. The drivers of more government involvement in markets are primarily non-commercial. Entry is dictated by a desire to offset market failures and exit is often delayed by the lobbying of those favourably affected by such interventions.
The risk of the latter is higher when market interventions lack a clear notion of when and how governments will exit, as well as delays in addressing unintended consequences. Business leaders now need to design strategies that recognise a more influential public policy risk factor.
Second, how will governments finance their growing involvement in the economy? Markets are increasingly worried about the longer-term cost of the rise in public sector borrowing. Given the huge numbers, policymakers must find a way to upgrade liability management approaches.
They must also signal their intention credibly to return to longer-term fiscal sustainability through the generation of meaningful primary budgetary surpluses.
Neither is easy. Yet the impact is far from straightforward. For example, we also have the Federal Reserve buying Treasuries, agencies and mortgages in the secondary markets. This means that with the Treasury as seller, we have two non-commercial players on different sides of the bid/offer in benchmark markets that also influence the levered financing of other instruments further down the risk spectrum.
Third, to what extent will this alter the role of the US in the global economy? The US supplies two critical global public goods: the reserve currency and deep and predictable financial markets. The rent it collects has allowed the US to contain funding costs and gain macro-policy flexibility.
The greater the questioning of these public goods, the more investors will reduce their large exposure to US assets. As such, the US may find it more difficult to operate like a large closed economy at a time when it has become a more open economy that is losing its size advantage gradually.
Fourth, how far will governments go in de-risking the financial system? The economic crisis of 2009, characterised by high and rising unemployment, is a result of the financial crisis of 2008. Expect even louder reactions from politicians, especially those facing elections in the next two years.
The politically driven de-risking reduces the credit that lubricates economic activity. While limiting systemic risk, this lowers the potential rate of growth and fuels significant consolidation in the financial services sector.
These four issues are consequential and call for a re-tooling of mindsets, institutions and approaches. Those who recognise this will fare better during a year that promises both the best and worst of times for businesses.
Treasury plans strict rules for securitisation
By Krishna Guha and Tom Braithwaite in Washington and Francesco Guerrera and Aline van Duyn in New York
The US Treasury is planning a sweeping overhaul of securitisation markets with tough new rules designed to restore confidence by reducing the incentive for lenders to originate bad loans and flip them on to investors.
The authorities plan to force lenders to retain part of the credit risk of the loans that are bundled into securities and to end the gain-on-sale accounting rules that helped spur the boom of the markets at the heart of the financial crisis.
The aim is to revitalise the markets for securities backed by mortgages and other assets without re-creating the systemic risks that turned boom to bust in 2007. The plan is part of a wider overhaul of regulation to be unveiled on Tuesday.
A Treasury spokesman said that while securitisation had made credit more widely available, breaking the direct link between borrower and lender had “led to a general erosion of lending standards, resulting in a serious market failure that fed the housing boom and deepened the housing bust”.
Securitised markets – which financed more than half of all credit in the US in the years immediately preceeding the crisis – are essential for the US economy. Without a recovery in these markets, the flow of credit will not return to more normal levels, even if US banks overcome their problems.
The Treasury hopes its plan will help bring these markets back to a more stable form by improving information and changing incentives. However, bankers warned that the new rules would reduce incentives to package assets into securities, raising financing costs.
“It is the beginning of the unwinding of the securitisation-for-sale model,” a senior Wall Street banker said. “By forcing lenders to keep part of the loans and scrapping ‘gain-for-sale’, the government will raise the cost of capital and put a damper on the reopening of credit markets.”
Some experts also question the wisdom of forcing banks to retain exposure to loans sold as securities, saying that it might be better to encourage banks to properly rid themselves of all exposure to such credits.
The Treasury plans to force lenders to retain at least 5 per cent of the credit risk of loans that are securitised, ensuring that they have what investors call “skin in the game”. The 5 per cent rule – which looks set to be applied in Europe as well – is less draconian than some bankers feared. The proposed elimination of “gain on sale accounting” is to prevent financial companies from booking paper profits on loans – packaged into securities – as soon as they were sold to investors.
Banks would only be able to record income from securitisation over time as payments are received. Brokers’ fees and commissions would also be disbursed over time rather than up front, and would be reduced if an asset performed badly due to bad underwriting.
The US authorities also plan to stop credit rating agencies from assigning the same types of ratings to structured credit products that are assigned to corporate and sovereign bonds, meaning there would be no more AAA-rated subprime securities.
Contracts would be standardised to ease comparability and trades included in an electronic database currently used for corporate bonds.
Sponsors would be required to stand behind their securities by providing warranties as to the origination and the underwriting standards on the loans.
Credit ratings agencies – most of which are paid by the issuers to rate securities – would have to strengthen their policies for handling conflicts of interest.
They would have to develop a new vocabulary to rate structured credit – a move intended to underscore the fact that a triple A rating on a corporate bond and on a mortgage-backed security mean very different things.
The US Treasury is planning a sweeping overhaul of securitisation markets with tough new rules designed to restore confidence by reducing the incentive for lenders to originate bad loans and flip them on to investors.
The authorities plan to force lenders to retain part of the credit risk of the loans that are bundled into securities and to end the gain-on-sale accounting rules that helped spur the boom of the markets at the heart of the financial crisis.
The aim is to revitalise the markets for securities backed by mortgages and other assets without re-creating the systemic risks that turned boom to bust in 2007. The plan is part of a wider overhaul of regulation to be unveiled on Tuesday.
A Treasury spokesman said that while securitisation had made credit more widely available, breaking the direct link between borrower and lender had “led to a general erosion of lending standards, resulting in a serious market failure that fed the housing boom and deepened the housing bust”.
Securitised markets – which financed more than half of all credit in the US in the years immediately preceeding the crisis – are essential for the US economy. Without a recovery in these markets, the flow of credit will not return to more normal levels, even if US banks overcome their problems.
The Treasury hopes its plan will help bring these markets back to a more stable form by improving information and changing incentives. However, bankers warned that the new rules would reduce incentives to package assets into securities, raising financing costs.
“It is the beginning of the unwinding of the securitisation-for-sale model,” a senior Wall Street banker said. “By forcing lenders to keep part of the loans and scrapping ‘gain-for-sale’, the government will raise the cost of capital and put a damper on the reopening of credit markets.”
Some experts also question the wisdom of forcing banks to retain exposure to loans sold as securities, saying that it might be better to encourage banks to properly rid themselves of all exposure to such credits.
The Treasury plans to force lenders to retain at least 5 per cent of the credit risk of loans that are securitised, ensuring that they have what investors call “skin in the game”. The 5 per cent rule – which looks set to be applied in Europe as well – is less draconian than some bankers feared. The proposed elimination of “gain on sale accounting” is to prevent financial companies from booking paper profits on loans – packaged into securities – as soon as they were sold to investors.
Banks would only be able to record income from securitisation over time as payments are received. Brokers’ fees and commissions would also be disbursed over time rather than up front, and would be reduced if an asset performed badly due to bad underwriting.
The US authorities also plan to stop credit rating agencies from assigning the same types of ratings to structured credit products that are assigned to corporate and sovereign bonds, meaning there would be no more AAA-rated subprime securities.
Contracts would be standardised to ease comparability and trades included in an electronic database currently used for corporate bonds.
Sponsors would be required to stand behind their securities by providing warranties as to the origination and the underwriting standards on the loans.
Credit ratings agencies – most of which are paid by the issuers to rate securities – would have to strengthen their policies for handling conflicts of interest.
They would have to develop a new vocabulary to rate structured credit – a move intended to underscore the fact that a triple A rating on a corporate bond and on a mortgage-backed security mean very different things.
Monday, June 15, 2009
Hotel Bankruptcy Spares Key Investor
By LINGLING WEI and KRIS HUDSON
In one of the biggest real-estate bankruptcies in the current slump, the Extended Stay Hotels chain filed for Chapter 11 protection Monday, collapsing under the debt from its $8 billion top-of-the-market buyout in 2007.
But David Lichtenstein, whose Lightstone Group LLC led the buyout group, appears to be surviving Extended Stay's meltdown relatively unscathed. Lightstone contributed only $200 million of equity and borrowed a chunk of that for the deal, according to people familiar with the matter.
Under a proposed restructuring plan with major creditors, the 48-year-old Mr. Lichtenstein would avoid personal guarantees in the original loan agreement. He would also be kept on as manager of the 680-property hotel chain. Mr. Lichtenstein on Monday declined to comment.
In contrast, creditors include some of the country's biggest banks and even possibly U.S. taxpayers, as one of the lenders was Bear Stearns, whose stake was taken over by the Federal Reserve after Bear collapsed in March 2008. As a result, the Fed had $744 million in par amount in various junior classes of the debt on Extended Stay; it also held $153 million in the senior debt that was packaged and sold as bonds. A New York Fed spokeswoman declined to comment.
Extended Stay's problems are partly due to hard times in the hotel industry. But the hotel chain's major problem was debt.
One mortgage holder who supports the plan said Mr. Lichtenstein exercised his "fiduciary duty" in filing for bankruptcy.
The high-wire act marks the latest coup for Mr. Lichtenstein, the son of two Brooklyn school teachers, who came out of nowhere to build a real-estate empire. That empire was valued at $13 billion at its peak but is now struggling, a sign of the spreading carnage in the commercial real-estate industry.
Still, Mr. Lichtenstein's situation shows that the architects of some of the largest deals are finding ways to limit their losses. In Mr. Lichtenstein's case it also helped that the capital structure was so complicated, enabling him to benefit from the infighting among different groups of creditors.
The hotel chain is now valued at $3.3 billion, according to its filing. That figure isn't even 60% of the buyout price and even lower than the amount of the first mortgage, $4.1 billion.
Extended Stay's problems are partly due to hard times in the hotel industry. But the hotel chain's major problem was debt. The buyout group larded Extended Stay with $7.4 billion in debt on the assumption that the chain's cash flow would increase sharply. At the time of the deal, it was generating $545 million a year in earnings before capital expenditures. The group and its lenders, led by Wachovia, based its underwriting on the prediction that would increase to $625 million within two years.
Such optimistic assumptions were the norm in commercial real-estate during the bubble leading up to the current recession. Cheap debt was available because banks could easily sell it as commercial mortgage backed securities, or CMBS, to investors chasing yields. More than $700 billion in CMBS is outstanding, and on uncertain legal footing in bankruptcy court.
Many investors thought that Extended Stay wouldn't be able to file for bankruptcy because of a "bad boy" provision in the CMBS structure. According to the loan documents, Mr. Lichtenstein would become liable personally for $100 million if Extended Stay filed for Chapter 11 protection. But Mr. Lichtenstein reached a deal with secured lenders who have been negotiating a restructuring plan. Under that deal, lenders agreed to indemnify him up to $100 million in exchange for him supporting the plan that would put the lenders in control of the hotel chain.
It is unclear if he would be personally liable for the loan he borrowed to finance his equity stake.
As the ones left holding the bag, investors in the junior or "mezzanine" debt sued Extended Stay and its bank lenders this month in an effort to prevent them from seizing control.
—Mike Spector and Jeffrey McCracken contributed to this article.
Write to Lingling Wei at lingling.wei@dowjones.com and Kris Hudson at kris.hudson@wsj.com
In one of the biggest real-estate bankruptcies in the current slump, the Extended Stay Hotels chain filed for Chapter 11 protection Monday, collapsing under the debt from its $8 billion top-of-the-market buyout in 2007.
But David Lichtenstein, whose Lightstone Group LLC led the buyout group, appears to be surviving Extended Stay's meltdown relatively unscathed. Lightstone contributed only $200 million of equity and borrowed a chunk of that for the deal, according to people familiar with the matter.
Under a proposed restructuring plan with major creditors, the 48-year-old Mr. Lichtenstein would avoid personal guarantees in the original loan agreement. He would also be kept on as manager of the 680-property hotel chain. Mr. Lichtenstein on Monday declined to comment.
In contrast, creditors include some of the country's biggest banks and even possibly U.S. taxpayers, as one of the lenders was Bear Stearns, whose stake was taken over by the Federal Reserve after Bear collapsed in March 2008. As a result, the Fed had $744 million in par amount in various junior classes of the debt on Extended Stay; it also held $153 million in the senior debt that was packaged and sold as bonds. A New York Fed spokeswoman declined to comment.
Extended Stay's problems are partly due to hard times in the hotel industry. But the hotel chain's major problem was debt.
One mortgage holder who supports the plan said Mr. Lichtenstein exercised his "fiduciary duty" in filing for bankruptcy.
The high-wire act marks the latest coup for Mr. Lichtenstein, the son of two Brooklyn school teachers, who came out of nowhere to build a real-estate empire. That empire was valued at $13 billion at its peak but is now struggling, a sign of the spreading carnage in the commercial real-estate industry.
Still, Mr. Lichtenstein's situation shows that the architects of some of the largest deals are finding ways to limit their losses. In Mr. Lichtenstein's case it also helped that the capital structure was so complicated, enabling him to benefit from the infighting among different groups of creditors.
The hotel chain is now valued at $3.3 billion, according to its filing. That figure isn't even 60% of the buyout price and even lower than the amount of the first mortgage, $4.1 billion.
Extended Stay's problems are partly due to hard times in the hotel industry. But the hotel chain's major problem was debt. The buyout group larded Extended Stay with $7.4 billion in debt on the assumption that the chain's cash flow would increase sharply. At the time of the deal, it was generating $545 million a year in earnings before capital expenditures. The group and its lenders, led by Wachovia, based its underwriting on the prediction that would increase to $625 million within two years.
Such optimistic assumptions were the norm in commercial real-estate during the bubble leading up to the current recession. Cheap debt was available because banks could easily sell it as commercial mortgage backed securities, or CMBS, to investors chasing yields. More than $700 billion in CMBS is outstanding, and on uncertain legal footing in bankruptcy court.
Many investors thought that Extended Stay wouldn't be able to file for bankruptcy because of a "bad boy" provision in the CMBS structure. According to the loan documents, Mr. Lichtenstein would become liable personally for $100 million if Extended Stay filed for Chapter 11 protection. But Mr. Lichtenstein reached a deal with secured lenders who have been negotiating a restructuring plan. Under that deal, lenders agreed to indemnify him up to $100 million in exchange for him supporting the plan that would put the lenders in control of the hotel chain.
It is unclear if he would be personally liable for the loan he borrowed to finance his equity stake.
As the ones left holding the bag, investors in the junior or "mezzanine" debt sued Extended Stay and its bank lenders this month in an effort to prevent them from seizing control.
—Mike Spector and Jeffrey McCracken contributed to this article.
Write to Lingling Wei at lingling.wei@dowjones.com and Kris Hudson at kris.hudson@wsj.com
European Banks Don't Seem Overstressed
By SIMON NIXON
We've done our bit, now it's your turn. That's what U.S. policy makers are telling their European counterparts.
U.S. banks have passed stress tests, raised capital and many are set to repay government funds. European banks, so the argument goes, have done less to rebuild confidence in the system and are short of capital -- a view apparently shared by some at the European Central Bank. Is it true?
The market doesn't seem to think so. European bank stocks have rallied alongside U.S. rivals since early March. Analysts no longer focus on whether banks have enough capital but what returns they can make as the economy stabilizes. Few now expect the Europeans to follow U.S. rivals and raise new capital from governments or the markets.
In fact, European banks don't appear that stressed, based on criteria used for the U.S. Supervisory Capital Assessment Program tests. These required banks, under stressed economic scenarios through 2010, to have Tier 1 common equity to risk-weighted assets of 4% and core Tier 1 capital to risk-weighted assets of 6%.
It is hard to make an assessment purely on published information, but Deutsche Bank reckons that, of 41 banks it has analyzed, just five would fail the common equity test.
The saving grace for European banks was the U.S. decision to use risk-weighted capital measures for its test. On a total leverage basis, European banks don't compare so well. European banks have common equity equivalent to 2.8% of tangible assets compared with 3.5% in the U.S., according to Morgan Stanley. The International Monetary Fund recently estimated European banks will need an extra $600 billion of capital to ensure common equity to tangible assets remains at least 4%.
But this higher leverage reflects the different ways U.S. and European balance sheets have evolved. U.S. banks were partly subject to an overall leverage ratio, while European banks were operating under Basel II, incentivizing them to run high leverage but retain assets that carried lower risk weightings.
For example, European banks have higher exposure to corporate loans, equivalent to 43% of loan books compared with 26% in the U.S., while 16% of U.S. loans are in the relatively risky second-lien mortgage market, according to Deutsche Bank.
Besides, European governments haven't sat on their hands. Every country has supported its banks, whether by providing capital, guarantees or insurance against toxic asset losses.
Of course, European banks still face big challenges. Nordic banks are heavily exposed to the struggling Baltic states. Irish and Spanish banks face collapsing domestic economies. Unlisted savings banks in Spain, Germany and the U.K. may face particular problems. Meanwhile, the structure of European bank balance sheets may mean the big stresses only emerge later in the cycle as unemployment continues rising, corporate defaults pick up and some supposedly safe securities turn out to be risky after all.
Meanwhile profits may not recover fast as the market expects. One reason analysts are relaxed about European banks: They are increasingly confident banks can generate enough capital organically to retain their strength as credit losses are incurred. But funding costs are rising, the future regulatory picture remains unclear and there's no guarantee buoyant investment banking revenues can be sustained.
The market may be right that European banks can cope with these risks in the absence of further capital injections -- although, without a fully transparent European stress test, nobody can be certain. Perhaps the bigger concern is that the banks find themselves unable to provide the new lending necessary to support a recovery. But that's a potential problem for the U.S., too, despite TARP.
Write to Simon Nixon at simon.nixon@wsj.com
We've done our bit, now it's your turn. That's what U.S. policy makers are telling their European counterparts.
U.S. banks have passed stress tests, raised capital and many are set to repay government funds. European banks, so the argument goes, have done less to rebuild confidence in the system and are short of capital -- a view apparently shared by some at the European Central Bank. Is it true?
The market doesn't seem to think so. European bank stocks have rallied alongside U.S. rivals since early March. Analysts no longer focus on whether banks have enough capital but what returns they can make as the economy stabilizes. Few now expect the Europeans to follow U.S. rivals and raise new capital from governments or the markets.
In fact, European banks don't appear that stressed, based on criteria used for the U.S. Supervisory Capital Assessment Program tests. These required banks, under stressed economic scenarios through 2010, to have Tier 1 common equity to risk-weighted assets of 4% and core Tier 1 capital to risk-weighted assets of 6%.
It is hard to make an assessment purely on published information, but Deutsche Bank reckons that, of 41 banks it has analyzed, just five would fail the common equity test.
The saving grace for European banks was the U.S. decision to use risk-weighted capital measures for its test. On a total leverage basis, European banks don't compare so well. European banks have common equity equivalent to 2.8% of tangible assets compared with 3.5% in the U.S., according to Morgan Stanley. The International Monetary Fund recently estimated European banks will need an extra $600 billion of capital to ensure common equity to tangible assets remains at least 4%.
But this higher leverage reflects the different ways U.S. and European balance sheets have evolved. U.S. banks were partly subject to an overall leverage ratio, while European banks were operating under Basel II, incentivizing them to run high leverage but retain assets that carried lower risk weightings.
For example, European banks have higher exposure to corporate loans, equivalent to 43% of loan books compared with 26% in the U.S., while 16% of U.S. loans are in the relatively risky second-lien mortgage market, according to Deutsche Bank.
Besides, European governments haven't sat on their hands. Every country has supported its banks, whether by providing capital, guarantees or insurance against toxic asset losses.
Of course, European banks still face big challenges. Nordic banks are heavily exposed to the struggling Baltic states. Irish and Spanish banks face collapsing domestic economies. Unlisted savings banks in Spain, Germany and the U.K. may face particular problems. Meanwhile, the structure of European bank balance sheets may mean the big stresses only emerge later in the cycle as unemployment continues rising, corporate defaults pick up and some supposedly safe securities turn out to be risky after all.
Meanwhile profits may not recover fast as the market expects. One reason analysts are relaxed about European banks: They are increasingly confident banks can generate enough capital organically to retain their strength as credit losses are incurred. But funding costs are rising, the future regulatory picture remains unclear and there's no guarantee buoyant investment banking revenues can be sustained.
The market may be right that European banks can cope with these risks in the absence of further capital injections -- although, without a fully transparent European stress test, nobody can be certain. Perhaps the bigger concern is that the banks find themselves unable to provide the new lending necessary to support a recovery. But that's a potential problem for the U.S., too, despite TARP.
Write to Simon Nixon at simon.nixon@wsj.com
Stay the Course
PAUL KRUGMAN
Published: June 14, 2009
The debate over economic policy has taken a predictable yet ominous turn: the crisis seems to be easing, and a chorus of critics is already demanding that the Federal Reserve and the Obama administration abandon their rescue efforts. For those who know their history, it’s déjà vu all over again — literally.
For this is the third time in history that a major economy has found itself in a liquidity trap, a situation in which interest-rate cuts, the conventional way to perk up the economy, have reached their limit. When this happens, unconventional measures are the only way to fight recession.
Yet such unconventional measures make the conventionally minded uncomfortable, and they keep pushing for a return to normalcy. In previous liquidity-trap episodes, policy makers gave in to these pressures far too soon, plunging the economy back into crisis. And if the critics have their way, we’ll do the same thing this time.
The first example of policy in a liquidity trap comes from the 1930s. The U.S. economy grew rapidly from 1933 to 1937, helped along by New Deal policies. America, however, remained well short of full employment.
Yet policy makers stopped worrying about depression and started worrying about inflation. The Federal Reserve tightened monetary policy, while F.D.R. tried to balance the federal budget. Sure enough, the economy slumped again, and full recovery had to wait for World War II.
The second example is Japan in the 1990s. After slumping early in the decade, Japan experienced a partial recovery, with the economy growing almost 3 percent in 1996. Policy makers responded by shifting their focus to the budget deficit, raising taxes and cutting spending. Japan proceeded to slide back into recession.
And here we go again.
On one side, the inflation worriers are harassing the Fed. The latest example: Arthur Laffer, he of the curve, warns that the Fed’s policies will cause devastating inflation. He recommends, among other things, possibly raising banks’ reserve requirements, which happens to be exactly what the Fed did in 1936 and 1937 — a move that none other than Milton Friedman condemned as helping to strangle economic recovery.
Meanwhile, there are demands from several directions that President Obama’s fiscal stimulus plan be canceled.
Some, especially in Europe, argue that stimulus isn’t needed, because the economy is already turning around.
Others claim that government borrowing is driving up interest rates, and that this will derail recovery.
And Republicans, providing a bit of comic relief, are saying that the stimulus has failed, because the enabling legislation was passed four months ago — wow, four whole months! — yet unemployment is still rising. This suggests an interesting comparison with the economic record of Ronald Reagan, whose 1981 tax cut was followed by no less than 16 months of rising unemployment.
O.K., time for some reality checks.
First of all, while stock markets have been celebrating the economy’s “green shoots,” the fact is that unemployment is very high and still rising. That is, we’re not even experiencing the kind of growth that led to the big mistakes of 1937 and 1997. It’s way too soon to declare victory.
What about the claim that the Fed is risking inflation? It isn’t. Mr. Laffer seems panicked by a rapid rise in the monetary base, the sum of currency in circulation and the reserves of banks. But a rising monetary base isn’t inflationary when you’re in a liquidity trap. America’s monetary base doubled between 1929 and 1939; prices fell 19 percent. Japan’s monetary base rose 85 percent between 1997 and 2003; deflation continued apace.
Well then, what about all that government borrowing? All it’s doing is offsetting a plunge in private borrowing — total borrowing is down, not up. Indeed, if the government weren’t running a big deficit right now, the economy would probably be well on its way to a full-fledged depression.
Oh, and investors’ growing confidence that we’ll manage to avoid a full-fledged depression — not the pressure of government borrowing — explains the recent rise in long-term interest rates. These rates, by the way, are still low by historical standards. They’re just not as low as they were at the peak of the panic, earlier this year.
To sum up: A few months ago the U.S. economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual.
Those demands should be ignored. It’s much too soon to give up on policies that have, at most, pulled us a few inches back from the edge of the abyss.
Published: June 14, 2009
The debate over economic policy has taken a predictable yet ominous turn: the crisis seems to be easing, and a chorus of critics is already demanding that the Federal Reserve and the Obama administration abandon their rescue efforts. For those who know their history, it’s déjà vu all over again — literally.
For this is the third time in history that a major economy has found itself in a liquidity trap, a situation in which interest-rate cuts, the conventional way to perk up the economy, have reached their limit. When this happens, unconventional measures are the only way to fight recession.
Yet such unconventional measures make the conventionally minded uncomfortable, and they keep pushing for a return to normalcy. In previous liquidity-trap episodes, policy makers gave in to these pressures far too soon, plunging the economy back into crisis. And if the critics have their way, we’ll do the same thing this time.
The first example of policy in a liquidity trap comes from the 1930s. The U.S. economy grew rapidly from 1933 to 1937, helped along by New Deal policies. America, however, remained well short of full employment.
Yet policy makers stopped worrying about depression and started worrying about inflation. The Federal Reserve tightened monetary policy, while F.D.R. tried to balance the federal budget. Sure enough, the economy slumped again, and full recovery had to wait for World War II.
The second example is Japan in the 1990s. After slumping early in the decade, Japan experienced a partial recovery, with the economy growing almost 3 percent in 1996. Policy makers responded by shifting their focus to the budget deficit, raising taxes and cutting spending. Japan proceeded to slide back into recession.
And here we go again.
On one side, the inflation worriers are harassing the Fed. The latest example: Arthur Laffer, he of the curve, warns that the Fed’s policies will cause devastating inflation. He recommends, among other things, possibly raising banks’ reserve requirements, which happens to be exactly what the Fed did in 1936 and 1937 — a move that none other than Milton Friedman condemned as helping to strangle economic recovery.
Meanwhile, there are demands from several directions that President Obama’s fiscal stimulus plan be canceled.
Some, especially in Europe, argue that stimulus isn’t needed, because the economy is already turning around.
Others claim that government borrowing is driving up interest rates, and that this will derail recovery.
And Republicans, providing a bit of comic relief, are saying that the stimulus has failed, because the enabling legislation was passed four months ago — wow, four whole months! — yet unemployment is still rising. This suggests an interesting comparison with the economic record of Ronald Reagan, whose 1981 tax cut was followed by no less than 16 months of rising unemployment.
O.K., time for some reality checks.
First of all, while stock markets have been celebrating the economy’s “green shoots,” the fact is that unemployment is very high and still rising. That is, we’re not even experiencing the kind of growth that led to the big mistakes of 1937 and 1997. It’s way too soon to declare victory.
What about the claim that the Fed is risking inflation? It isn’t. Mr. Laffer seems panicked by a rapid rise in the monetary base, the sum of currency in circulation and the reserves of banks. But a rising monetary base isn’t inflationary when you’re in a liquidity trap. America’s monetary base doubled between 1929 and 1939; prices fell 19 percent. Japan’s monetary base rose 85 percent between 1997 and 2003; deflation continued apace.
Well then, what about all that government borrowing? All it’s doing is offsetting a plunge in private borrowing — total borrowing is down, not up. Indeed, if the government weren’t running a big deficit right now, the economy would probably be well on its way to a full-fledged depression.
Oh, and investors’ growing confidence that we’ll manage to avoid a full-fledged depression — not the pressure of government borrowing — explains the recent rise in long-term interest rates. These rates, by the way, are still low by historical standards. They’re just not as low as they were at the peak of the panic, earlier this year.
To sum up: A few months ago the U.S. economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual.
Those demands should be ignored. It’s much too soon to give up on policies that have, at most, pulled us a few inches back from the edge of the abyss.
TPG Scores in Its Sale of Shenzhen
By RICK CAREW
HONG KONG -- TPG has reached a deal to sell its controlling stake in Shenzhen Development Bank to China's No. 2 insurer for $1.68 billion, marking a successful exit for one of the private-equity industry's more notable investments in China.
Ping An Insurance (Group) Co. of China agreed to take control of Shenzhen Development, one of China's 10 biggest banks, by subscribing to as much as $1.6 billion worth of new shares issued by the Chinese bank in a private placement and then buying TPG's 17% stake. TPG has the option of receiving payment in cash or receiving a 3.9% stake in Ping An. TPG must decide whether to exercise the option to take shares or cash before Dec. 24, 2010. The deal, which the Wall Street Journal reported last week was close to agreement, is contingent on regulatory approval.
Nearly five years ago, TPG's Asian arm, Newbridge Capital, made a risky bet that it could turn around Shenzhen Development, which was saddled with bad loans and poor lending practices.
The bet has paid off in a spectacular fashion. If TPG decides to take the cash option, the $1.68 billion it will receive is around five times the cash it invested, which consisted of an original outlay of $150 million in addition to between $150 million and $200 million that TPG later paid for warrants in the bank.
TPG's investment didn't always run smoothly. The fund found itself at odds with China's securities regulators' plans to regularize the bank's share structure. Like most listed companies, Shenzhen Development had certain shares deemed "nontradable," and making them tradable required tricky negotiations. While TPG waged a controversial public campaign against the preference of regulators to give away free shares to small shareholders as part of a deal, TPG eventually agreed to just that.
TPG struggled to raise capital levels at Shenzhen Development to reach regulatory requirements, given the bank's legacy of bad loans. In 2005, TPG struck a deal to sell a $100 million stake in the bank to General Electric Co., only to see it expire after delays over the share-reform dispute. As time dragged on, a run-up in Shenzhen Development's share price amid a broad rally in China's domestic markets made it impossible to renegotiate a deal after the original terms looked too cheap.
But despite its problems, TPG's investment paved the way for much larger outlays by foreign investors in China's banking sector that included Bank of America Corp., Goldman Sachs Group Inc. and Royal Bank of Scotland PLC. Most of these have sold off or reduced their Chinese bank stakes this year at a profit as they rebuild balance sheets battered by the financial crisis.
Under the terms of the deal announced over the weekend, Ping An agreed to buy between 370 million and 585 million new shares in Shenzhen Development for 18.26 yuan ($2.67) apiece, the average of the bank's shares over the last 20 trading sessions. Ping An is offering to pay 22 yuan a share for TPG's stake. Ping An's stake is expected to rise to 30% under the deal from the 4.68% stake in Shenzhen Development it currently holds.
Shenzhen-based Ping An, the country's second-largest insurer by premiums after China Life Insurance Co., is a natural buyer for the stake. Beyond sharing the same hometown, acquiring a bigger stake in Shenzhen Development will help the insurer further branch out into banking. Ping An Chairman Peter Ma envisions turning the insurer into a diversified financial conglomerate by beefing up its banking and asset-management businesses.
Ping An made an ill-timed investment in Fortis NV in late 2007 that cost it about $3 billion, and had to scrap a $3.4 billion deal to form an asset-management joint venture with Fortis.
Write to Rick Carew at rick.carew@wsj.com
HONG KONG -- TPG has reached a deal to sell its controlling stake in Shenzhen Development Bank to China's No. 2 insurer for $1.68 billion, marking a successful exit for one of the private-equity industry's more notable investments in China.
Ping An Insurance (Group) Co. of China agreed to take control of Shenzhen Development, one of China's 10 biggest banks, by subscribing to as much as $1.6 billion worth of new shares issued by the Chinese bank in a private placement and then buying TPG's 17% stake. TPG has the option of receiving payment in cash or receiving a 3.9% stake in Ping An. TPG must decide whether to exercise the option to take shares or cash before Dec. 24, 2010. The deal, which the Wall Street Journal reported last week was close to agreement, is contingent on regulatory approval.
Nearly five years ago, TPG's Asian arm, Newbridge Capital, made a risky bet that it could turn around Shenzhen Development, which was saddled with bad loans and poor lending practices.
The bet has paid off in a spectacular fashion. If TPG decides to take the cash option, the $1.68 billion it will receive is around five times the cash it invested, which consisted of an original outlay of $150 million in addition to between $150 million and $200 million that TPG later paid for warrants in the bank.
TPG's investment didn't always run smoothly. The fund found itself at odds with China's securities regulators' plans to regularize the bank's share structure. Like most listed companies, Shenzhen Development had certain shares deemed "nontradable," and making them tradable required tricky negotiations. While TPG waged a controversial public campaign against the preference of regulators to give away free shares to small shareholders as part of a deal, TPG eventually agreed to just that.
TPG struggled to raise capital levels at Shenzhen Development to reach regulatory requirements, given the bank's legacy of bad loans. In 2005, TPG struck a deal to sell a $100 million stake in the bank to General Electric Co., only to see it expire after delays over the share-reform dispute. As time dragged on, a run-up in Shenzhen Development's share price amid a broad rally in China's domestic markets made it impossible to renegotiate a deal after the original terms looked too cheap.
But despite its problems, TPG's investment paved the way for much larger outlays by foreign investors in China's banking sector that included Bank of America Corp., Goldman Sachs Group Inc. and Royal Bank of Scotland PLC. Most of these have sold off or reduced their Chinese bank stakes this year at a profit as they rebuild balance sheets battered by the financial crisis.
Under the terms of the deal announced over the weekend, Ping An agreed to buy between 370 million and 585 million new shares in Shenzhen Development for 18.26 yuan ($2.67) apiece, the average of the bank's shares over the last 20 trading sessions. Ping An is offering to pay 22 yuan a share for TPG's stake. Ping An's stake is expected to rise to 30% under the deal from the 4.68% stake in Shenzhen Development it currently holds.
Shenzhen-based Ping An, the country's second-largest insurer by premiums after China Life Insurance Co., is a natural buyer for the stake. Beyond sharing the same hometown, acquiring a bigger stake in Shenzhen Development will help the insurer further branch out into banking. Ping An Chairman Peter Ma envisions turning the insurer into a diversified financial conglomerate by beefing up its banking and asset-management businesses.
Ping An made an ill-timed investment in Fortis NV in late 2007 that cost it about $3 billion, and had to scrap a $3.4 billion deal to form an asset-management joint venture with Fortis.
Write to Rick Carew at rick.carew@wsj.com
Auto Suppliers Attempt Reinvention
By TIMOTHY AEPPEL
The auto-industry meltdown is forcing a transformation among automotive suppliers, which are slowly diversifying into more-promising markets such as medical devices and green energy.
The shift to nonautomotive products is under way at Abbott Workholding Products Inc. The Manhattan, Kan., company, whose industrial tools are used by the auto industry, now makes tools used to craft artificial knees and bone reinforcements. Elsewhere, Delphi Corp. is considering adapting its electric-car batteries for use in residential energy systems.
"If you're really tied to auto, you're sweating bullets," says Abbott Chief Executive Carl Reed. "Those are the guys desperately trying to find something else."
Bloomberg News
Delphi auto parts lined the shelf of a New Jersey warehouse last year.
Many auto suppliers, however, won't be able to make the change. A wave of bankruptcy filings is already swamping the sector, and some industry experts predict that as many as 20% of the industry's 1,700 core suppliers could go under this year. That figure doesn't include the far larger number of smaller businesses further down the supply chain, many of which are also under financial stress.
Moving into new markets often requires adapting the production process to serve a new type of customer. "It's not as easy as it sounds," says Cliff Waldman, an economist with the Manufacturers Alliance/MAPI, an Arlington, Va., trade association. "The cost of that transition to a small business may be tougher than the benefit they'll get over the long term."
Even larger companies are finding the transition difficult. Take Delphi, which recently tried to use its electronics expertise to make high-efficiency, industrial light bulbs at one of its factories in Indiana. The Troy, Mich., company abandoned that effort a few months ago before making a single bulb.
The problem, Delphi found, was that its production system was geared toward long-term contracts for high-volume products, whereas the light bulbs were to be made in lower volumes and under short-term contracts to better respond to the marketplace.
"We're used to a steady flow, which gives the best cost position -- versus spasmodic orders," says Paul Ainslie, who heads the small team of Delphi engineers looking for ways to adapt the company's electronics for other markets.
Abbott is seeking opportunities in the alternative-energy industry and the medical market. The company recently sold a set of six, 7-foot-tall, 8-foot-wide tooling columns, aluminum structures used in the manufacture of solar panels.
Mr. Reed, Abbott's CEO, says he isn't trying to reduce his exposure to autos, but rather focus on developing other sectors.
The key is picking the right sectors. Die-Matic Corp., a metal stamper based in Brooklyn Heights, Ohio, had 65% of its business tied up in autos and has the rest in construction, mining and small appliances. While those latter businesses have done better than the auto sector, the company is looking for higher-growth markets such as the medical industry.
Bill Shepard, sales manager for Die-Matic, says it will have to change the way finished products are handled and shipped. Medical companies want parts shipped clean. Many auto parts are shipping with a coating of oil, which means Die-Matic would have to set up a system for washing the parts.
"They also want parts protected more and in smaller boxes," he says.
The transformation is possible. WJG Enterprise Co., a 55-employee plastics company in Charlotte, Mich., was 100%-oriented toward selling to the auto industry until late last year. It made parts for air conditioners, decorative trim pieces for doors, and speaker housings. The company has since developed a business making plastics for medical devices -- including pieces used on X-ray machines and magnetic-resonance imaging equipment, and measuring cups used in medical settings.
William Grice, the company's founder and CEO, says the only equipment he had to invest in were seven new molds, which cost a total of $1.2 million. The new molds run in his existing machines. He expects automotive to represent only 46% of his business by year end.
Some suppliers are sticking to autos, rather than risk a potentially costly and unsuccessful foray into other markets. Pittsburgh Glass Works LLC is one of them. The auto-glass maker's strategy is to shrink its business to fit the smaller demand of the U.S. auto sector.
"Our focus has been on our footprint -- with plant closures and right-sizing," says Joe Stas, a spokesman for Pittsburgh Glass Works. "We see a smaller market, but possibly a more-profitable one going forward."
Write to Timothy Aeppel at timothy.aeppel@wsj.com
The auto-industry meltdown is forcing a transformation among automotive suppliers, which are slowly diversifying into more-promising markets such as medical devices and green energy.
The shift to nonautomotive products is under way at Abbott Workholding Products Inc. The Manhattan, Kan., company, whose industrial tools are used by the auto industry, now makes tools used to craft artificial knees and bone reinforcements. Elsewhere, Delphi Corp. is considering adapting its electric-car batteries for use in residential energy systems.
"If you're really tied to auto, you're sweating bullets," says Abbott Chief Executive Carl Reed. "Those are the guys desperately trying to find something else."
Bloomberg News
Delphi auto parts lined the shelf of a New Jersey warehouse last year.
Many auto suppliers, however, won't be able to make the change. A wave of bankruptcy filings is already swamping the sector, and some industry experts predict that as many as 20% of the industry's 1,700 core suppliers could go under this year. That figure doesn't include the far larger number of smaller businesses further down the supply chain, many of which are also under financial stress.
Moving into new markets often requires adapting the production process to serve a new type of customer. "It's not as easy as it sounds," says Cliff Waldman, an economist with the Manufacturers Alliance/MAPI, an Arlington, Va., trade association. "The cost of that transition to a small business may be tougher than the benefit they'll get over the long term."
Even larger companies are finding the transition difficult. Take Delphi, which recently tried to use its electronics expertise to make high-efficiency, industrial light bulbs at one of its factories in Indiana. The Troy, Mich., company abandoned that effort a few months ago before making a single bulb.
The problem, Delphi found, was that its production system was geared toward long-term contracts for high-volume products, whereas the light bulbs were to be made in lower volumes and under short-term contracts to better respond to the marketplace.
"We're used to a steady flow, which gives the best cost position -- versus spasmodic orders," says Paul Ainslie, who heads the small team of Delphi engineers looking for ways to adapt the company's electronics for other markets.
Abbott is seeking opportunities in the alternative-energy industry and the medical market. The company recently sold a set of six, 7-foot-tall, 8-foot-wide tooling columns, aluminum structures used in the manufacture of solar panels.
Mr. Reed, Abbott's CEO, says he isn't trying to reduce his exposure to autos, but rather focus on developing other sectors.
The key is picking the right sectors. Die-Matic Corp., a metal stamper based in Brooklyn Heights, Ohio, had 65% of its business tied up in autos and has the rest in construction, mining and small appliances. While those latter businesses have done better than the auto sector, the company is looking for higher-growth markets such as the medical industry.
Bill Shepard, sales manager for Die-Matic, says it will have to change the way finished products are handled and shipped. Medical companies want parts shipped clean. Many auto parts are shipping with a coating of oil, which means Die-Matic would have to set up a system for washing the parts.
"They also want parts protected more and in smaller boxes," he says.
The transformation is possible. WJG Enterprise Co., a 55-employee plastics company in Charlotte, Mich., was 100%-oriented toward selling to the auto industry until late last year. It made parts for air conditioners, decorative trim pieces for doors, and speaker housings. The company has since developed a business making plastics for medical devices -- including pieces used on X-ray machines and magnetic-resonance imaging equipment, and measuring cups used in medical settings.
William Grice, the company's founder and CEO, says the only equipment he had to invest in were seven new molds, which cost a total of $1.2 million. The new molds run in his existing machines. He expects automotive to represent only 46% of his business by year end.
Some suppliers are sticking to autos, rather than risk a potentially costly and unsuccessful foray into other markets. Pittsburgh Glass Works LLC is one of them. The auto-glass maker's strategy is to shrink its business to fit the smaller demand of the U.S. auto sector.
"Our focus has been on our footprint -- with plant closures and right-sizing," says Joe Stas, a spokesman for Pittsburgh Glass Works. "We see a smaller market, but possibly a more-profitable one going forward."
Write to Timothy Aeppel at timothy.aeppel@wsj.com
Sunday, June 14, 2009
Is This Bull Cyclical or Secular?
By TOM LAURICELLA
Many investors are now calling the rebound in stocks since early March the start of a new bull market. But it could be only a temporary respite from a longer-term bear market dating back to the beginning of this decade.
If the market is poised for a multiyear run, investors can be more aggressive about diving into stocks. If the bear market will regain its grip on stocks and send prices lower again, investors need to be cautious.
Historical data and the still struggling economy seem to point to the latter case, called a cyclical bull market in a secular bear market.
For now, stocks are fully in bull-market territory, even if it doesn't feel that way given the losses that many investors are still nursing.
After falling 33.8% last year, the Dow Jones Industrial Average finished last week 34% above its 12-year closing low on March 9. The Standard & Poor's 500-stock index is up nearly 40% from its low on that date.
The traditional definition of a bull market is a 20% gain from a low point and a bear market is a 20% decline from a high. But the Dow remains 38% below its record close in October 2007, and the S&P is nearly 40% below its record.
Even those who believe a more stable economy and lots of cash sitting on the sidelines will send the market higher remain cautious.
"We have some very substantial headwinds on the economic front," says David Pedowitz, a senior portfolio manager at Neuberger Berman.
Consumer spending is strained and there is significant excess capacity in the manufacturing economy, he says. Against that backdrop, expectations may be building for a bigger rebound in profits than will be possible, says Mr. Pedowitz.
In late 2001, Ned Davis Research, a market analysis and money-management firm, raised the idea that stocks had entered a secular bear market, a long period of flat or declining stocks. That idea gained traction last autumn as stocks fell below levels of a decade ago.
Ned Davis considers this the fourth secular bear market since 1900. The last one, from 1966 to 1982, ended when the Federal Reserve moved to aggressively crush inflation.
These "secular" cycles run for long periods; secular bull markets have lasted from six to 24 years and bear markets 13 to 16 years.
Within those cycles are many more cyclical bulls and bears -- nearly three dozen of each since 1900. (Ned Davis uses its own criteria for a cyclical bull or bear market, based largely on 30% moves.)
During a secular bull market, the cyclical, or shorter, bull markets within them gained 110% on average and lasted nearly three years. Within secular bear markets, however, the gains in cyclical bull markets averaged 64% and generally were over within a year and a half.
That could mean the current rally has a little more than a year to run but already has made more than half its gains. Still, stocks may not fall all the way back their lows this March. In the 1970s, for example, stocks hit what turned out to be their low in 1974 but went on to have three more cyclical bear markets before turning higher in 1982.
Ned Davis Research says the rise in stocks since March 9 qualifies as a bull market, but doesn't see the most recent low as marking a transition into a new secular rally. That is in part because, according to the firm's calculations, market valuations didn't fall far enough during the sell-off.
To calculate price-to-earnings ratios, Ned Davis focuses on as-reported earnings rather than operating profit, which excludes lots of one-time write-offs. In addition, its researchers avoid complications caused by negative earnings, which distort P/E ratios, and focus on the median P/E of the stocks in the S&P 500. On that basis, the S&P fell to a P/E of roughly 12 in early March and is now just shy of 16, which compares to a 40-year median of 16.5.
"You compare that to the 1970s where we got down to P/Es below 10 and stayed there until 1982," says Tim Hayes, chief investment strategist at Ned Davis. The current secular bear market, he says, "is mature but it can go on for another several years."
It is possible, Mr. Hayes says, that the current bull market will extend into next year but then get derailed by rising interest rates and inflation. Eventually, significantly higher inflation would likely boost earnings but depress stock prices, sending P/Es to the kinds of levels that might mark the beginning of a new secular uptrend.
In the meantime, Mr. Hayes says investors may want to focus on what they see as a secular bull market in commodities that has been under way for the past seven to nine years.
"We're recommending having some exposure to commodities and gold," he says.
For now, at least, those who think this is the beginning of a long-lasting bull market are few and far between. Among them is James Paulsen, chief investment strategist at Wells Capital Management. Mr. Paulsen, who stayed largely optimistic even during the worst of last year's market collapse, in part argues that the U.S. economy is healthier than widely believed and exports will provide a bigger boost than in the past.
Neuberger Berman's Mr. Pedowitz, meanwhile, is remaining cautious with part of the money he manages, while another portion is making more aggressive bets. "You want to maintain a balance in the portfolio between defensive and offensive" holdings, he says.
He's keeping roughly 15% of his portfolios in cash. "That gives you plenty of capital if the market retreats and some dry powder" should bargains appear.
He also has stocks that he counts as defensive, such as Cisco Systems and Oracle, which should profit as companies try to improve their efficiency during a tough economy. He also likes Teva Pharmaceuticals as a firm that he believes will benefit from health-care reform, unlike many other companies in the sector.
Then, for the offensive side of his portfolio, Mr. Pedowitz owns J.P. Morgan Chase, along with economically sensitive stocks such as manufacturers Danaher and Roper Industries.
It's simply too early to tell whether the March 9 lows were merely a cyclical bull market or the start of a secular bull, says Milton Ezrati, market strategist at Lord Abbett. "That will depend on how durable the economic recovery is," he says. "The jury is still out."
But he believes there are opportunities in companies whose stocks do best early in an economic cycle, such as industrials, some commodities and consumer-discretionary stocks. "We can see this rally being sustained, although there could be short-term corrections," Mr. Ezrati says.
Some financials make a "good trading play," he says, and could rally as concerns about bad real-estate loans start to fade as the economy stabilizes. However, "there are questions about their fundamental businesses" that could cap gains over the next year or two.
Neuberger Berman's Mr. Pedowitz has a word of caution for investors. "Make absolutely sure you have been humbled enough by the markets to know that you can't really tell if this is a cyclical or secular bull market."
Write to Tom Lauricella at tom.lauricella@wsj.com
Many investors are now calling the rebound in stocks since early March the start of a new bull market. But it could be only a temporary respite from a longer-term bear market dating back to the beginning of this decade.
If the market is poised for a multiyear run, investors can be more aggressive about diving into stocks. If the bear market will regain its grip on stocks and send prices lower again, investors need to be cautious.
Historical data and the still struggling economy seem to point to the latter case, called a cyclical bull market in a secular bear market.
For now, stocks are fully in bull-market territory, even if it doesn't feel that way given the losses that many investors are still nursing.
After falling 33.8% last year, the Dow Jones Industrial Average finished last week 34% above its 12-year closing low on March 9. The Standard & Poor's 500-stock index is up nearly 40% from its low on that date.
The traditional definition of a bull market is a 20% gain from a low point and a bear market is a 20% decline from a high. But the Dow remains 38% below its record close in October 2007, and the S&P is nearly 40% below its record.
Even those who believe a more stable economy and lots of cash sitting on the sidelines will send the market higher remain cautious.
"We have some very substantial headwinds on the economic front," says David Pedowitz, a senior portfolio manager at Neuberger Berman.
Consumer spending is strained and there is significant excess capacity in the manufacturing economy, he says. Against that backdrop, expectations may be building for a bigger rebound in profits than will be possible, says Mr. Pedowitz.
In late 2001, Ned Davis Research, a market analysis and money-management firm, raised the idea that stocks had entered a secular bear market, a long period of flat or declining stocks. That idea gained traction last autumn as stocks fell below levels of a decade ago.
Ned Davis considers this the fourth secular bear market since 1900. The last one, from 1966 to 1982, ended when the Federal Reserve moved to aggressively crush inflation.
These "secular" cycles run for long periods; secular bull markets have lasted from six to 24 years and bear markets 13 to 16 years.
Within those cycles are many more cyclical bulls and bears -- nearly three dozen of each since 1900. (Ned Davis uses its own criteria for a cyclical bull or bear market, based largely on 30% moves.)
During a secular bull market, the cyclical, or shorter, bull markets within them gained 110% on average and lasted nearly three years. Within secular bear markets, however, the gains in cyclical bull markets averaged 64% and generally were over within a year and a half.
That could mean the current rally has a little more than a year to run but already has made more than half its gains. Still, stocks may not fall all the way back their lows this March. In the 1970s, for example, stocks hit what turned out to be their low in 1974 but went on to have three more cyclical bear markets before turning higher in 1982.
Ned Davis Research says the rise in stocks since March 9 qualifies as a bull market, but doesn't see the most recent low as marking a transition into a new secular rally. That is in part because, according to the firm's calculations, market valuations didn't fall far enough during the sell-off.
To calculate price-to-earnings ratios, Ned Davis focuses on as-reported earnings rather than operating profit, which excludes lots of one-time write-offs. In addition, its researchers avoid complications caused by negative earnings, which distort P/E ratios, and focus on the median P/E of the stocks in the S&P 500. On that basis, the S&P fell to a P/E of roughly 12 in early March and is now just shy of 16, which compares to a 40-year median of 16.5.
"You compare that to the 1970s where we got down to P/Es below 10 and stayed there until 1982," says Tim Hayes, chief investment strategist at Ned Davis. The current secular bear market, he says, "is mature but it can go on for another several years."
It is possible, Mr. Hayes says, that the current bull market will extend into next year but then get derailed by rising interest rates and inflation. Eventually, significantly higher inflation would likely boost earnings but depress stock prices, sending P/Es to the kinds of levels that might mark the beginning of a new secular uptrend.
In the meantime, Mr. Hayes says investors may want to focus on what they see as a secular bull market in commodities that has been under way for the past seven to nine years.
"We're recommending having some exposure to commodities and gold," he says.
For now, at least, those who think this is the beginning of a long-lasting bull market are few and far between. Among them is James Paulsen, chief investment strategist at Wells Capital Management. Mr. Paulsen, who stayed largely optimistic even during the worst of last year's market collapse, in part argues that the U.S. economy is healthier than widely believed and exports will provide a bigger boost than in the past.
Neuberger Berman's Mr. Pedowitz, meanwhile, is remaining cautious with part of the money he manages, while another portion is making more aggressive bets. "You want to maintain a balance in the portfolio between defensive and offensive" holdings, he says.
He's keeping roughly 15% of his portfolios in cash. "That gives you plenty of capital if the market retreats and some dry powder" should bargains appear.
He also has stocks that he counts as defensive, such as Cisco Systems and Oracle, which should profit as companies try to improve their efficiency during a tough economy. He also likes Teva Pharmaceuticals as a firm that he believes will benefit from health-care reform, unlike many other companies in the sector.
Then, for the offensive side of his portfolio, Mr. Pedowitz owns J.P. Morgan Chase, along with economically sensitive stocks such as manufacturers Danaher and Roper Industries.
It's simply too early to tell whether the March 9 lows were merely a cyclical bull market or the start of a secular bull, says Milton Ezrati, market strategist at Lord Abbett. "That will depend on how durable the economic recovery is," he says. "The jury is still out."
But he believes there are opportunities in companies whose stocks do best early in an economic cycle, such as industrials, some commodities and consumer-discretionary stocks. "We can see this rally being sustained, although there could be short-term corrections," Mr. Ezrati says.
Some financials make a "good trading play," he says, and could rally as concerns about bad real-estate loans start to fade as the economy stabilizes. However, "there are questions about their fundamental businesses" that could cap gains over the next year or two.
Neuberger Berman's Mr. Pedowitz has a word of caution for investors. "Make absolutely sure you have been humbled enough by the markets to know that you can't really tell if this is a cyclical or secular bull market."
Write to Tom Lauricella at tom.lauricella@wsj.com
中国民众收入感受指数创了10年新低
据中国之声15时05分报道，中国人民银行昨天公布了5月中下旬在全国50个大中小城市进行的城镇储户问卷调查结果。Mitbbs.com
数据显示，当前居民对未来就业形势持悲观情绪，认为当前就业形势不乐观，城镇居民消费更加谨慎，买房意愿持续低位徘徊，买车意愿回升。Mitbbs.com
央行调查显示，目前居民对他们的收入感受指数首次降到了负值区间，二季度城镇居民当期收入感受指数为-8.6%，比一季度下降20个百分点，是 1999年开展调查以来的最低水平。同时对未来的收入预期也非常不乐观，只有3.4%，和去年、前年同期相比下降了14%和17%，居民对当前的就业形势也很不乐观，超过45%的居民认为现在就业形势很严峻，比一季度更难。对下季度就业预期比本季度好一点，但也是负数。Mitbbs.com
消费方面，被调查居民对物价满意程度非常低，超过40%的居民认为物价很高，难以接受。这个比例比上个季度增加了20个百分点，接近07年下半年到08年上半年CPI在最高位时的水平。认为物价可以接受或令人满意的居民占比分别降至53.3%和3.5%。Mitbbs.com
大家可能会觉得很奇怪，我们CPI现在是负数，为什么大家觉得物价很高，难以接受呢？这是因为大家对收入的预期更加强烈，物价下降的速度没有大家对于收入下降速度感受那么快，所以同样情况下大家觉得物价很高，对物价感受不满意，因此居民消费意愿下降很快。另外储蓄和投资意愿增强，将近一半的城镇居民安排资金的时候，选择更多地储蓄，不愿意去消费，这个比例目前达到历史最高位。只有15.1%的城镇居民认为目前还是可以更多地消费，但是这个比值目前也是历史上最低的。Mitbbs.com
此外，超过6成的居民认为房价高，难以接受，同时也认为今后房价会越来越高，不房价看跌的比例非常少。大家对房价有一个奇怪的心理，看涨不看跌。相反，大家对购车的意愿一直保持在很高的水平，达到了百分之十二点多。这个原因主要是和鼓励消费的政策
数据显示，当前居民对未来就业形势持悲观情绪，认为当前就业形势不乐观，城镇居民消费更加谨慎，买房意愿持续低位徘徊，买车意愿回升。Mitbbs.com
央行调查显示，目前居民对他们的收入感受指数首次降到了负值区间，二季度城镇居民当期收入感受指数为-8.6%，比一季度下降20个百分点，是 1999年开展调查以来的最低水平。同时对未来的收入预期也非常不乐观，只有3.4%，和去年、前年同期相比下降了14%和17%，居民对当前的就业形势也很不乐观，超过45%的居民认为现在就业形势很严峻，比一季度更难。对下季度就业预期比本季度好一点，但也是负数。Mitbbs.com
消费方面，被调查居民对物价满意程度非常低，超过40%的居民认为物价很高，难以接受。这个比例比上个季度增加了20个百分点，接近07年下半年到08年上半年CPI在最高位时的水平。认为物价可以接受或令人满意的居民占比分别降至53.3%和3.5%。Mitbbs.com
大家可能会觉得很奇怪，我们CPI现在是负数，为什么大家觉得物价很高，难以接受呢？这是因为大家对收入的预期更加强烈，物价下降的速度没有大家对于收入下降速度感受那么快，所以同样情况下大家觉得物价很高，对物价感受不满意，因此居民消费意愿下降很快。另外储蓄和投资意愿增强，将近一半的城镇居民安排资金的时候，选择更多地储蓄，不愿意去消费，这个比例目前达到历史最高位。只有15.1%的城镇居民认为目前还是可以更多地消费，但是这个比值目前也是历史上最低的。Mitbbs.com
此外，超过6成的居民认为房价高，难以接受，同时也认为今后房价会越来越高，不房价看跌的比例非常少。大家对房价有一个奇怪的心理，看涨不看跌。相反，大家对购车的意愿一直保持在很高的水平，达到了百分之十二点多。这个原因主要是和鼓励消费的政策
Playing for Growth in Corporate Bonds
By RICHARD BARLEY
Will rising government-bond yields upset the slam-dunk trade of the year: investment-grade corporate bonds? After all, 10-year Treasury yields hit 4% this week, from just over 2% earlier this year. The risks have risen, but company debt still looks attractive.
The relationship between corporate- and government-bond yields isn't straightforward. The drivers of corporate-bond performance tend to be default rates, economic growth and shocks to risk appetite. Since 1970, corporate-bond-yield spreads have actually tended to widen more often when government-bond yields fall than when they rise, according to Dresdner Kleinwort.
The key is to understand why government-bond yields are rising. If investors believe in an economic recovery and have more risk appetite, that is good for corporate bonds, as creditworthiness should recover along with profits.
If it is because inflation expectations are rising, that is usually negative for fixed-income investments. But even though there is a risk that ultraloose monetary policy helps stoke inflation longer term, it looks under control for now.
Meanwhile, if rising government-bond yields reflect concerns about the huge amount of paper needed to fund record deficits, that would be negative for corporate bonds. Companies could find themselves forced to pay higher yields to lure investors back.
For institutional investors, government-bond yields remain some way below levels that would cause big allocation shifts; BNP Paribas estimates these triggers lie between 4.5% and 7.5%. The bigger risk: individual investors, a source of demand for corporate bonds this year, get spooked, and the tide of money coming into the market slows or reverses.
At this point, there is no reason why they should. Government yields still are relatively low by historical standards. Meanwhile, U.S. corporate-bond yields of 6%-7% look relatively attractive in a low-interest-rate world. And spreads still are wide, meaning investors have a generous cushion to absorb losses.
Now stocks have run up so quickly, corporate bonds are a lower-risk way to bet on continued healing in the economy.
Write to Richard Barley at richard.barley@dowjones.com
Will rising government-bond yields upset the slam-dunk trade of the year: investment-grade corporate bonds? After all, 10-year Treasury yields hit 4% this week, from just over 2% earlier this year. The risks have risen, but company debt still looks attractive.
The relationship between corporate- and government-bond yields isn't straightforward. The drivers of corporate-bond performance tend to be default rates, economic growth and shocks to risk appetite. Since 1970, corporate-bond-yield spreads have actually tended to widen more often when government-bond yields fall than when they rise, according to Dresdner Kleinwort.
The key is to understand why government-bond yields are rising. If investors believe in an economic recovery and have more risk appetite, that is good for corporate bonds, as creditworthiness should recover along with profits.
If it is because inflation expectations are rising, that is usually negative for fixed-income investments. But even though there is a risk that ultraloose monetary policy helps stoke inflation longer term, it looks under control for now.
Meanwhile, if rising government-bond yields reflect concerns about the huge amount of paper needed to fund record deficits, that would be negative for corporate bonds. Companies could find themselves forced to pay higher yields to lure investors back.
For institutional investors, government-bond yields remain some way below levels that would cause big allocation shifts; BNP Paribas estimates these triggers lie between 4.5% and 7.5%. The bigger risk: individual investors, a source of demand for corporate bonds this year, get spooked, and the tide of money coming into the market slows or reverses.
At this point, there is no reason why they should. Government yields still are relatively low by historical standards. Meanwhile, U.S. corporate-bond yields of 6%-7% look relatively attractive in a low-interest-rate world. And spreads still are wide, meaning investors have a generous cushion to absorb losses.
Now stocks have run up so quickly, corporate bonds are a lower-risk way to bet on continued healing in the economy.
Write to Richard Barley at richard.barley@dowjones.com
Six Flags Files for Chapter 11
By MIKE SPECTOR
Six Flags Inc., one of the largest regional amusement-park companies, filed for bankruptcy protection Saturday.
The theme-park company, shouldering more than $2 billion in debt, had been negotiating with lenders, selling parks and laying off staff in a race to restructure outside of bankruptcy court. But it couldn't outrun the deteriorating economy and a looming $288 million payment due preferred shareholders this August, along with $31 million in unpaid dividends.
Six Flags hopes to exit bankruptcy quickly through a prearranged reorganization plan. It struck a deal with senior secured lenders that would allow it convert $1.8 billion in debt to equity.
The plan was backed by J.P. Morgan Chase & Co., the agent for the facility, and a steering committee of lenders, according to court documents. The support represents half the facility's obligations, the company said. The plan would also wipe out more than $300 million in preferred stock obligations.
Six Flags listed assets of $3 billion and liabilities of $3.4 billion, including $2.4 billion in debt at the end of March. Among its largest unsecured creditors were HSBC Bank USA with $400 million in bond debt and Bank of New York Mellon, holding more than $500 million in the company's debt.
The filing marked another highly-leveraged company falling victim to the deep recession. Six Flags' 20 parks dot North America, with operations in Chicago, San Antonio and Mexico City. Revenue in the first quarter fell 24% and the company delayed certain debt payments. Several of the park company's subsidiaries also filed for protection from creditors.
The Chapter 11 filing is a setback for investor Daniel Snyder, the Washington Redskins football team owner who took control of the theme-park company in a contentious proxy fight in 2005 and installed his own management team. The bankruptcy would likely wipe out Mr. Snyder's 6% stake.
In the midst of his battle to wrest control of the company, Mr. Snyder wrote a letter to Six Flags stockholders saying they "would have been better off hiding their money under a mattress" than investing in the company under its prior management.
"The current management team inherited a $2.4 billion debt load that cannot be sustained, particularly in these challenging financial markets," said Mark Shapiro, Six Flags' chief executive, in a statement. He said operations of the company's parks would be unaffected by the filing and that Chapter 11 protection was sought solely to "clean up the balance sheet."
Also losing out on Six Flags' financial rollercoaster: Microsoft Corp. founder Bill Gates, whose Cascade Investment LLC owned about 10.2 million shares, or an 11% stake. Other big equity holders include Dwight Schar, a Six Flags board member and part-owner of the Redskins alongside Mr. Snyder with a 5% stake; Citigroup Inc. with 9%; Barclays PLC with 6.7%; and hedge fund Renaissance Technologies LLC with 5.5%.
Six Flags warned earlier this year it could file for bankruptcy if it failed to reap concessions from lenders. Since April, it had been in discussions with lenders about a debt-for-equity swap, but failed to get enough takers.
A deadline for debt holders to swap certain notes for equity expired Friday night. Six Flags had extended that deadline by more than two weeks after falling well short of a 95% targeted acceptance rate.
Mr. Snyder's team, led by Mr. Shapiro, a former ESPN executive, had made some progress of late. Six Flags sold 10 parks and laid off about 300 workers. It tried to make its parks more family friendly, banning smoking in most areas.
Last year, Six Flags brought in more cash than it spent for the first time. Its losses narrowed in 2008 to $112.9 million, about half those of a year earlier. Sales nudge 5% higher to about $1.02 billion.
But last summer's record fuel prices, plunging consumer confidence and deteriorating credit markets weighed on Six Flags' balance sheet. The company lost even more money when the recent swine flu outbreak forced a temporary closure of its park in Mexico City.
A few months ago, Six Flags hired law firm Paul Hastings Janofsky & Walker LLP to prepare for a bankruptcy filing. It also hired Houlihan Lokey Howard & Zukin to negotiate with creditors.
Write to Mike Spector at mike.spector@wsj.com
Six Flags Inc., one of the largest regional amusement-park companies, filed for bankruptcy protection Saturday.
The theme-park company, shouldering more than $2 billion in debt, had been negotiating with lenders, selling parks and laying off staff in a race to restructure outside of bankruptcy court. But it couldn't outrun the deteriorating economy and a looming $288 million payment due preferred shareholders this August, along with $31 million in unpaid dividends.
Six Flags hopes to exit bankruptcy quickly through a prearranged reorganization plan. It struck a deal with senior secured lenders that would allow it convert $1.8 billion in debt to equity.
The plan was backed by J.P. Morgan Chase & Co., the agent for the facility, and a steering committee of lenders, according to court documents. The support represents half the facility's obligations, the company said. The plan would also wipe out more than $300 million in preferred stock obligations.
Six Flags listed assets of $3 billion and liabilities of $3.4 billion, including $2.4 billion in debt at the end of March. Among its largest unsecured creditors were HSBC Bank USA with $400 million in bond debt and Bank of New York Mellon, holding more than $500 million in the company's debt.
The filing marked another highly-leveraged company falling victim to the deep recession. Six Flags' 20 parks dot North America, with operations in Chicago, San Antonio and Mexico City. Revenue in the first quarter fell 24% and the company delayed certain debt payments. Several of the park company's subsidiaries also filed for protection from creditors.
The Chapter 11 filing is a setback for investor Daniel Snyder, the Washington Redskins football team owner who took control of the theme-park company in a contentious proxy fight in 2005 and installed his own management team. The bankruptcy would likely wipe out Mr. Snyder's 6% stake.
In the midst of his battle to wrest control of the company, Mr. Snyder wrote a letter to Six Flags stockholders saying they "would have been better off hiding their money under a mattress" than investing in the company under its prior management.
"The current management team inherited a $2.4 billion debt load that cannot be sustained, particularly in these challenging financial markets," said Mark Shapiro, Six Flags' chief executive, in a statement. He said operations of the company's parks would be unaffected by the filing and that Chapter 11 protection was sought solely to "clean up the balance sheet."
Also losing out on Six Flags' financial rollercoaster: Microsoft Corp. founder Bill Gates, whose Cascade Investment LLC owned about 10.2 million shares, or an 11% stake. Other big equity holders include Dwight Schar, a Six Flags board member and part-owner of the Redskins alongside Mr. Snyder with a 5% stake; Citigroup Inc. with 9%; Barclays PLC with 6.7%; and hedge fund Renaissance Technologies LLC with 5.5%.
Six Flags warned earlier this year it could file for bankruptcy if it failed to reap concessions from lenders. Since April, it had been in discussions with lenders about a debt-for-equity swap, but failed to get enough takers.
A deadline for debt holders to swap certain notes for equity expired Friday night. Six Flags had extended that deadline by more than two weeks after falling well short of a 95% targeted acceptance rate.
Mr. Snyder's team, led by Mr. Shapiro, a former ESPN executive, had made some progress of late. Six Flags sold 10 parks and laid off about 300 workers. It tried to make its parks more family friendly, banning smoking in most areas.
Last year, Six Flags brought in more cash than it spent for the first time. Its losses narrowed in 2008 to $112.9 million, about half those of a year earlier. Sales nudge 5% higher to about $1.02 billion.
But last summer's record fuel prices, plunging consumer confidence and deteriorating credit markets weighed on Six Flags' balance sheet. The company lost even more money when the recent swine flu outbreak forced a temporary closure of its park in Mexico City.
A few months ago, Six Flags hired law firm Paul Hastings Janofsky & Walker LLP to prepare for a bankruptcy filing. It also hired Houlihan Lokey Howard & Zukin to negotiate with creditors.
Write to Mike Spector at mike.spector@wsj.com
Stocks in the Black on Gusher of Cash
By E.S. BROWNING
With a 34% rebound in three months, the Dow Jones Industrial Average has pushed into positive territory for 2009, and one of the main reasons is disarmingly simple: Financial markets once again are awash in government cash.
The Dow rose 28.34 points to 8799.26 on Friday, as money managers continued shifting funds into stocks. Still, the Dow remains down 38% from its 2007 record of 14164.53, and it had seemed to plateau in recent weeks on worries about the strength of the global recovery.
Is the economy on the mend? But governments around the world are pumping money into the economy at a frenetic pace. Because businesses can't put trillions of new dollars to work in such a short time, the money is finding its way into financial markets. Some investors have begun speaking of a "bailout bubble" being created in certain markets, and about a "melt-up" in demand fueled by the growing supply of money.
"All that money that was printed had to go somewhere," says Joachim Fels, co-head of global economics at Morgan Stanley. "It has been pushing up commodity prices and stock prices, starting in emerging markets and then pushing over into developed markets."
The U.S. government alone has allocated $11.4 trillion to direct and indirect stimulus in the past two years, of which about $2.4 trillion has been spent, according to an estimate by Daniel Clifton, head of policy research at New York's Strategas Research Partners. Most of the money has been pushed out in the past year.
The money is gushing from direct grants, central-bank lending, tax breaks, guarantees and other items. China has announced plans for $600 billion in direct stimulus spending; Russia, $290 billion; Britain, $147 billion; and Japan, $155 billion, according to Strategas. Those countries and others are spending trillions more indirectly.
"It is quite easily the biggest combined fiscal stimulus the world has ever seen in modern times," says Jim O'Neill, chief economist at Goldman Sachs. "That liquidity will impact anything that is sensitive to it, ranging from short-term fixed-income securities through stock prices through property prices and into people's personal wealth."
Some of the market gains, of course, reflect a bet by investors that the worst of the global recession is over, and that investments tied to global growth will be big beneficiaries. The heavy influx of money into the financial system has fueled those bets.
If the recession proves more lasting than the optimists believe, liquidity alone may not be enough to keep financial markets rising. American consumers, whose outlays account for more than two-thirds of U.S. economic output, have only begun to rein in spending and reduce debt, a process many economists expect to continue for years.
The growing liquidity also is creating serious policy challenges. Senior economists, including Federal Reserve Chairman Ben Bernanke in congressional testimony on June 3, have begun warning that the government can't keep piling up debt at current rates without creating severe financial problems.
In coming years, officials will need to raise taxes, cut spending, or both to mop up the ocean of liquidity they have created. That process could weigh on growth and stifle the market boom.
Meanwhile, yields of government bonds are rising in anticipation of heavy federal borrowing, and higher yields also hamper growth. On Friday, the yield on 10-year Treasury notes eased a bit to 3.783%, still well up from 2.203% in mid-January.
If the government fails to mop up the money, the consequence could be even worse: inflation and a collapsing dollar.
Past liquidity-driven booms haven't ended well. In 1998, the Federal Reserve injected cash into the economy to rescue teetering bond markets. The unintended outcome: Technology stocks soared and then cratered. After the government turned on the spigot in 2001 to stave off deflation, residential real estate surged and then collapsed.
Now, although almost all markets still are far from past highs, bubbles may be starting to inflate again in speculative foreign markets and other investments linked to global economic growth.
For the seventh time this month, the Dow traded above its closing level from last year and finally closed in a new high for 2009. Not all news was good, however, with commodities closing lower. Dave Kansas reports after the bell.
Silver is up 59% from December lows on futures markets; copper is up 90%; corn, 45%; and crude oil, 113%. Ukraine's stock market is up 125%, Vietnam's 116%, Indonesia's 76% and India's 87% from winter lows.
In Shanghai, crowds are back on weekends on Guangdong Road, where locals gather to chat stocks. Tan Viet Securities Co. in Hanoi says it is opening or reactivating 50 accounts a day, up from five to seven in March. Optima Securities, a brokerage firm in Indonesia, says the number of new accounts has doubled in the last three months.
The oil-price rebound is boosting costly projects such as western Canada's oil-sands fields. Imperial Oil Ltd., majority-owned by Exxon Mobil Corp., said May 25 that it is moving ahead with a delayed $8 billion project near Kearl Lake. Canada's stock index is up 41% since March 9.
U.S. markets have been among the tamer ones, although some stocks demolished in the downturn have surged, such as banks and home builders. So have companies linked to foreign growth, including Freeport-McMoRan Copper & Gold Inc. and Caterpillar Inc.
U.S. companies have reacted to the easier money by issuing new stocks and bonds. In May, Dealogic reported, more new stock was issued by existing companies in U.S. markets than at any time since 1995, when it began keeping records. May issuance of new dollar-denominated junk bonds was the heaviest since June 2007, and the fifth-highest monthly level on record.
Worries are spreading that, like previous liquidity-driven market surges, this one could end badly, though many investors believe that won't happen soon.
Money supply in major countries, as measured by cash and checking accounts, has been rising sharply relative to gross domestic product, or total value of goods and services, Morgan Stanley reports. Money supply relative to GDP is at the highest level of any period covered by Morgan Stanley's data, which go back to the 1970s.
That measure of money supply has tended to move in line with bull and bear markets. It was declining in the late 1980s, ahead of the 1987 crash and the 1990 bear market. It started expanding in 1995, as a major bull market began. It started pulling back in March 2000, as the stock market fell. It then began expanding at the start of 2001, ahead of the next bull, only to top out again at the end of 2006, ahead of the next bear. Now it is surging again.
A growing number of money managers are jumping back into stocks, some fearing they will fall behind the surging indexes or believing the world economy finally is poised to recover, led by developing countries.
"We're past the crisis," says Jeff Schappe, chief investment officer at BB&T Asset Management in Raleigh, N.C. "The most attractive opportunities are probably going to be in emerging markets and commodities over time."
Brett Gallagher, deputy chief investment officer at Artio Global Investors, a money-management arm of Zurich financial group Julius Baer Holdings, says that at some point, the stock market "probably has to correct. But right now, a lot of it is a reflection of the policies that global central banks and politicians have pursued, which are: Reflate at any cost. My guess is that it probably will run longer than fundamentals will dictate it should," just as the tech-stock and the real-estate bubbles did before they finally popped.
—Mark Gongloff and James T. Areddy contributed to this article.
Write to E.S. Browning at jim.browning@wsj.com
With a 34% rebound in three months, the Dow Jones Industrial Average has pushed into positive territory for 2009, and one of the main reasons is disarmingly simple: Financial markets once again are awash in government cash.
The Dow rose 28.34 points to 8799.26 on Friday, as money managers continued shifting funds into stocks. Still, the Dow remains down 38% from its 2007 record of 14164.53, and it had seemed to plateau in recent weeks on worries about the strength of the global recovery.
Is the economy on the mend? But governments around the world are pumping money into the economy at a frenetic pace. Because businesses can't put trillions of new dollars to work in such a short time, the money is finding its way into financial markets. Some investors have begun speaking of a "bailout bubble" being created in certain markets, and about a "melt-up" in demand fueled by the growing supply of money.
"All that money that was printed had to go somewhere," says Joachim Fels, co-head of global economics at Morgan Stanley. "It has been pushing up commodity prices and stock prices, starting in emerging markets and then pushing over into developed markets."
The U.S. government alone has allocated $11.4 trillion to direct and indirect stimulus in the past two years, of which about $2.4 trillion has been spent, according to an estimate by Daniel Clifton, head of policy research at New York's Strategas Research Partners. Most of the money has been pushed out in the past year.
The money is gushing from direct grants, central-bank lending, tax breaks, guarantees and other items. China has announced plans for $600 billion in direct stimulus spending; Russia, $290 billion; Britain, $147 billion; and Japan, $155 billion, according to Strategas. Those countries and others are spending trillions more indirectly.
"It is quite easily the biggest combined fiscal stimulus the world has ever seen in modern times," says Jim O'Neill, chief economist at Goldman Sachs. "That liquidity will impact anything that is sensitive to it, ranging from short-term fixed-income securities through stock prices through property prices and into people's personal wealth."
Some of the market gains, of course, reflect a bet by investors that the worst of the global recession is over, and that investments tied to global growth will be big beneficiaries. The heavy influx of money into the financial system has fueled those bets.
If the recession proves more lasting than the optimists believe, liquidity alone may not be enough to keep financial markets rising. American consumers, whose outlays account for more than two-thirds of U.S. economic output, have only begun to rein in spending and reduce debt, a process many economists expect to continue for years.
The growing liquidity also is creating serious policy challenges. Senior economists, including Federal Reserve Chairman Ben Bernanke in congressional testimony on June 3, have begun warning that the government can't keep piling up debt at current rates without creating severe financial problems.
In coming years, officials will need to raise taxes, cut spending, or both to mop up the ocean of liquidity they have created. That process could weigh on growth and stifle the market boom.
Meanwhile, yields of government bonds are rising in anticipation of heavy federal borrowing, and higher yields also hamper growth. On Friday, the yield on 10-year Treasury notes eased a bit to 3.783%, still well up from 2.203% in mid-January.
If the government fails to mop up the money, the consequence could be even worse: inflation and a collapsing dollar.
Past liquidity-driven booms haven't ended well. In 1998, the Federal Reserve injected cash into the economy to rescue teetering bond markets. The unintended outcome: Technology stocks soared and then cratered. After the government turned on the spigot in 2001 to stave off deflation, residential real estate surged and then collapsed.
Now, although almost all markets still are far from past highs, bubbles may be starting to inflate again in speculative foreign markets and other investments linked to global economic growth.
For the seventh time this month, the Dow traded above its closing level from last year and finally closed in a new high for 2009. Not all news was good, however, with commodities closing lower. Dave Kansas reports after the bell.
Silver is up 59% from December lows on futures markets; copper is up 90%; corn, 45%; and crude oil, 113%. Ukraine's stock market is up 125%, Vietnam's 116%, Indonesia's 76% and India's 87% from winter lows.
In Shanghai, crowds are back on weekends on Guangdong Road, where locals gather to chat stocks. Tan Viet Securities Co. in Hanoi says it is opening or reactivating 50 accounts a day, up from five to seven in March. Optima Securities, a brokerage firm in Indonesia, says the number of new accounts has doubled in the last three months.
The oil-price rebound is boosting costly projects such as western Canada's oil-sands fields. Imperial Oil Ltd., majority-owned by Exxon Mobil Corp., said May 25 that it is moving ahead with a delayed $8 billion project near Kearl Lake. Canada's stock index is up 41% since March 9.
U.S. markets have been among the tamer ones, although some stocks demolished in the downturn have surged, such as banks and home builders. So have companies linked to foreign growth, including Freeport-McMoRan Copper & Gold Inc. and Caterpillar Inc.
U.S. companies have reacted to the easier money by issuing new stocks and bonds. In May, Dealogic reported, more new stock was issued by existing companies in U.S. markets than at any time since 1995, when it began keeping records. May issuance of new dollar-denominated junk bonds was the heaviest since June 2007, and the fifth-highest monthly level on record.
Worries are spreading that, like previous liquidity-driven market surges, this one could end badly, though many investors believe that won't happen soon.
Money supply in major countries, as measured by cash and checking accounts, has been rising sharply relative to gross domestic product, or total value of goods and services, Morgan Stanley reports. Money supply relative to GDP is at the highest level of any period covered by Morgan Stanley's data, which go back to the 1970s.
That measure of money supply has tended to move in line with bull and bear markets. It was declining in the late 1980s, ahead of the 1987 crash and the 1990 bear market. It started expanding in 1995, as a major bull market began. It started pulling back in March 2000, as the stock market fell. It then began expanding at the start of 2001, ahead of the next bull, only to top out again at the end of 2006, ahead of the next bear. Now it is surging again.
A growing number of money managers are jumping back into stocks, some fearing they will fall behind the surging indexes or believing the world economy finally is poised to recover, led by developing countries.
"We're past the crisis," says Jeff Schappe, chief investment officer at BB&T Asset Management in Raleigh, N.C. "The most attractive opportunities are probably going to be in emerging markets and commodities over time."
Brett Gallagher, deputy chief investment officer at Artio Global Investors, a money-management arm of Zurich financial group Julius Baer Holdings, says that at some point, the stock market "probably has to correct. But right now, a lot of it is a reflection of the policies that global central banks and politicians have pursued, which are: Reflate at any cost. My guess is that it probably will run longer than fundamentals will dictate it should," just as the tech-stock and the real-estate bubbles did before they finally popped.
—Mark Gongloff and James T. Areddy contributed to this article.
Write to E.S. Browning at jim.browning@wsj.com
Why Did Congress Decide for Digital Switch
Congress decided four years ago the U.S. should switch to digital TV so some TV airwaves could be used for other things. Digital signals take just a fraction of the space of older, analog TV signals. Lawmakers set aside some of the airwaves for police and firefighters, and auctioned off the rest to wireless companies for almost $20 billion.
The switch was originally scheduled for February but was postponed to June 12 after Congress and the Obama administration worried millions of Americans weren't ready.
The switch was originally scheduled for February but was postponed to June 12 after Congress and the Obama administration worried millions of Americans weren't ready.
Saturday, June 13, 2009
Guest post: BRICS or CRIBS? – Meeting in Moscow to coordinate policy
by Edward Harrison of the site Credit Writedowns.
Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman has a good piece out today highlighting the differing economic policy agendas of the BRIC group (Brazil, Russia, India and China). In it he suggests CRIBS is a more appropriate moniker for the group as it is China and Russia leading the way for the four, with Brazil the least influential.
What is interesting is that these four very different countries are meeting next week, ostensibly to coordinate economic policy in order to increase their economic influence. Events at the last G-20 summit suggests that behind the scenes ad-hoc coordination has been ongoing for some time (see my post on the G-20 for a review of those events).
Brazil, Russia, India and China, now collectively known as the BRICs, will hold a summit in Russia on June 16th. Besides the Goldman-Sachs invented moniker, these countries have very little in common except for the fact that they believe, to seemingly varying degrees of intensity, that they deserve greater influence in the conduct of world affairs than they currently have. And given the enormity of US power, as hard-core realists, they know any increase in their power and influence will come at the expense of America’s.
The BRICs are on different sides of the terms of trade trends. Brazil and Russia benefit from higher commodity prices, while India and China prefer lower prices. All, except Russia are in the World Trade Organization. All but Brazil have nuclear weapons. While India and Brazil are democracies, China surely is not. While it may be premature to draw hard and fast conclusions about Russia, the direction does not look particularly promising.
Russia and China are permanent members of the United Nations Security Council. With their veto power there, they arguably have achieved greater political influence than in the economic sphere. Russian and Chinese influence is often sought in regional issues, like the Caucuses and North Korea. For their part, Brazil and India have quite different foreign policies. For Brazil, its immediate surroundings are considerably more peaceful than in Eastern and Central Europe, where the end of an empire has seen the birth of new states. India’s foreign policy challenges are dominated by Pakistan. Security Council membership remains in the realm of aspirations.
Edward here. So, obviously China and Russia have the biggest political clout. What about in economics? Marc is about to argue that the BRIC countries do not deserve the influence they are seeking. I do not agree. However, he does present a compelling argument.
CRIB
One of the most important reasons why the BRICs do not have the economic clout that they would like is frankly they don’t deserve it. Goldman-Sachs had a story (and more) to sell with its BRICs concept, but those same letters spell a real word, CRIB. The point is that the countries, outside of China, are not among the largest.
According to Bloomberg data, at the end of last year, China was the fourth largest economy ($3.2 trillion), behind the US, Japan, and Germany. This of course takes the Chinese data at face value, and given the often large gaps between energy production and reported GDP growth, as well as the amazing consistency of the pace of growth, many often cast a suspicious eye on Chinese data.
With a GDP of $1.3 trillion in 2008, Brazil was the 10th largest economy, though it is roughly half the size of France, which is the 6th largest economy. Russia and India were neck-and-neck for 11th and 12th places with each having produced about $1.2 trillion of goods and services last year. Spain’s economy is nearly 20% bigger than Russia’s and India’s, and it is the 8th largest economy. Together the BRICs account for a little more than 12% of the world’s GDP, and China alone accounts for half of that.
The BRICs are also small in terms of the depth of the capital markets. Together, according to Bloomberg data, they account for a little more than 6% of the world equity capitalization (MSCI World Index). What equities that are truly tradable are very limited and concentrated in a few names. Often the markets lack the kind of transparency that many Western investors are familiar with, even given the financial crisis.
There are various capital controls and the BRIC’s currencies are not freely convertible or tradable. The banks have managed to partially circumvent the restrictions of the domestic (on-shore) market by creating a parallel off-shore market and non-deliverable forward contracts. Rydex’s CurrencyTrust ETF that tracks the ruble (XRU) was launched at the end of last year and has drawn little interest. It boasts a lowly $5 million market cap (assets under management).
Girth Not Size
Political scientists often argue that one of the characteristics of power is that it is concordant. By that they essentially mean that by having one element of power, say economic prowess, one can achieve other elements of power, such as like cultural influence. And yet during the Cold War, Russia’s claim to world power relied almost exclusively on one element—its military might. Power is surely multi-dimensional, but one of the common characteristics of the BRICs are that their power is limited in breadth and depth.
Each of the BRICs has amassed a large level of reserves. Brazil has the least at about $205 billion, just below India’s $251 billion. Russia has almost as much as both of them put together with almost $410 billion. China dwarfs all of them, individually and collectively, with nearly $2 trillion in reserves. Together they account for a third of the world’s currency reserves.
Yet there is no reason to consider them as a unitary whole or that they will act in concert. To the contrary, they each seem to embrace their reserves differently. India seems to regard its reserves most traditionally; an insurance against future calamities. Brazil is more willing to use reserves for domestic purposes and operates in the foreign exchange market daily. Given that Russia defaulted a decade ago, it is little wonder that its large reserves, a third of GDP, are a sign of national pride. The run-down in reserves during the last five months of 2008 was more politically embarrassing than threatening from an economic point of view.
China’s massive reserves, more than a quarter of the world’s reserves, are as much a sign of its successes as its failures. Reserves accumulate as a function of China’s large trade surplus. Rather than increase the share of consumption in GDP, China’s own figures show that it has fallen. China remains reliant on exports. Reserves accumulate as the central bank absorbs some of the hot money coming into the country so as to neutralize its effect. Reserves also accumulate as China manages its exchange rate.
IMF Bonds
The BRICs appear to be under-presented in the International Monetary Fund. As we have seen they account for about 12% of the world economy and yet have a combined quota (vote) of 9.82%. Yet the representation is not as straight-forward as that. Consider that the US accounts for a quarter of the world’s economy and yet the US has a 16.77% weighted vote at the IMF.
The April G20 meeting resolved to raise more funds for the IMF. Some countries like Japan have lent the IMF money. The BRICs want to provide their funds in the form of SDR (Special Drawing Right) bonds. This dovetails nicely with their call to increase the use of the SDR.
Some esteemed money managers are reading into this a grave signal. According to Bloomberg reports, Mark Mobius, executive chairman of Templeton Asset Management, sees the desire for SDR bonds as a rebuke of US fiscal policy. Mohamed El-Erian, CEO of PIMCO, sees the purchases as evidence of accelerating rebalancing of the world economy.
But, it does not seem that it is about us as in the US, but rather about these countries trying to bolster their own prestige and gravitas by contributing to the IMF. It is a function of the wealth they have already attained (reserve accumulation), but says nothing about the challenges that lie ahead. Moreover, the moves are largely symbolic. The $10 billion worth of SDR bonds that Russia is going to procure is 2.5% of its reserves. The $50 billion China will provide is about 2.5% of its reserves as well. Russia is thus far the only BRIC to suggest it will purchase the SDR bonds with its Treasury holdings, which stood at about $138 billion at the end of March, according to US Treasury data. It does not amount to noteworthy diversification of reserves. Nor does it represent much of a diversification away from the dollar as the greenback accounts for 44% of an SDR-basket. The contribution that Japan is committed to is greater than all the BRICs combined. Although noticeably quiet on the subject, India is expected to provide $10 billion to the IMF.
Still an SDR bond market is innovative insofar as one does not exist at the moment. The IMF is expected to announce details later this month or next month. Rather than have to sell US Treasuries there has been some suggestion that the interested countries, which are likely to extend beyond the BRICs, may swap the Treasuries for the SDR bonds, minimizing any market impact. A newly formed SDR bond market will lack the breadth and depth to truly compete with the US Treasury market, though it might have some novelty appeal. The impact on the dollar will likely be marginal at best. An SDR bond market does not mean the SDR is a viable alternative to the dollar or is any closer to being the supra-sovereign reserve asset that some imagine.
I have two asides to this story that are unrelated to the main content.
The first has to do with Brown Brothers Harriman whose research I frequently cite. Visit their FX site here. I suggest you bookmark it. BBH is one of those smaller boutique not publicly traded companies on Wall Street (History here at Wikipedia). How many BBHs are going bankrupt? How many Lazards are feeding at the public trough asking for government handouts? You know the answer – zero. And it is no coincidence. These private companies and partnerships like Greenhill have a much different corporate governance ethos than the likes of Citigroup or Bank of America. Perhaps had Lehman, Goldman and Morgan Stanley remained partnerships, they would have been more prudent in their risk taking.
My second aside has to do with the term CRIBS. I like the moniker. But being the pop culture hound that I am, I couldn’t help but think of that MTV show called MTV Cribs where the likes of Shaquille O’Neal or Robbie Williams gives us a glimpse of how rich and successful they are. When Peter Schiff was on the Daily Show recently, Jon Stewart sarcastically rebutted Schiff by suggesting his America-as-an-indebted-Banana-Republic meme would mean an end to culturally enriching shows like MTV Cribs. I’ve attached the video below for your amusement.
And, for the record, despite my snarky remarks, I like the show Cribs. Very entertaining.
Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman has a good piece out today highlighting the differing economic policy agendas of the BRIC group (Brazil, Russia, India and China). In it he suggests CRIBS is a more appropriate moniker for the group as it is China and Russia leading the way for the four, with Brazil the least influential.
What is interesting is that these four very different countries are meeting next week, ostensibly to coordinate economic policy in order to increase their economic influence. Events at the last G-20 summit suggests that behind the scenes ad-hoc coordination has been ongoing for some time (see my post on the G-20 for a review of those events).
Brazil, Russia, India and China, now collectively known as the BRICs, will hold a summit in Russia on June 16th. Besides the Goldman-Sachs invented moniker, these countries have very little in common except for the fact that they believe, to seemingly varying degrees of intensity, that they deserve greater influence in the conduct of world affairs than they currently have. And given the enormity of US power, as hard-core realists, they know any increase in their power and influence will come at the expense of America’s.
The BRICs are on different sides of the terms of trade trends. Brazil and Russia benefit from higher commodity prices, while India and China prefer lower prices. All, except Russia are in the World Trade Organization. All but Brazil have nuclear weapons. While India and Brazil are democracies, China surely is not. While it may be premature to draw hard and fast conclusions about Russia, the direction does not look particularly promising.
Russia and China are permanent members of the United Nations Security Council. With their veto power there, they arguably have achieved greater political influence than in the economic sphere. Russian and Chinese influence is often sought in regional issues, like the Caucuses and North Korea. For their part, Brazil and India have quite different foreign policies. For Brazil, its immediate surroundings are considerably more peaceful than in Eastern and Central Europe, where the end of an empire has seen the birth of new states. India’s foreign policy challenges are dominated by Pakistan. Security Council membership remains in the realm of aspirations.
Edward here. So, obviously China and Russia have the biggest political clout. What about in economics? Marc is about to argue that the BRIC countries do not deserve the influence they are seeking. I do not agree. However, he does present a compelling argument.
CRIB
One of the most important reasons why the BRICs do not have the economic clout that they would like is frankly they don’t deserve it. Goldman-Sachs had a story (and more) to sell with its BRICs concept, but those same letters spell a real word, CRIB. The point is that the countries, outside of China, are not among the largest.
According to Bloomberg data, at the end of last year, China was the fourth largest economy ($3.2 trillion), behind the US, Japan, and Germany. This of course takes the Chinese data at face value, and given the often large gaps between energy production and reported GDP growth, as well as the amazing consistency of the pace of growth, many often cast a suspicious eye on Chinese data.
With a GDP of $1.3 trillion in 2008, Brazil was the 10th largest economy, though it is roughly half the size of France, which is the 6th largest economy. Russia and India were neck-and-neck for 11th and 12th places with each having produced about $1.2 trillion of goods and services last year. Spain’s economy is nearly 20% bigger than Russia’s and India’s, and it is the 8th largest economy. Together the BRICs account for a little more than 12% of the world’s GDP, and China alone accounts for half of that.
The BRICs are also small in terms of the depth of the capital markets. Together, according to Bloomberg data, they account for a little more than 6% of the world equity capitalization (MSCI World Index). What equities that are truly tradable are very limited and concentrated in a few names. Often the markets lack the kind of transparency that many Western investors are familiar with, even given the financial crisis.
There are various capital controls and the BRIC’s currencies are not freely convertible or tradable. The banks have managed to partially circumvent the restrictions of the domestic (on-shore) market by creating a parallel off-shore market and non-deliverable forward contracts. Rydex’s CurrencyTrust ETF that tracks the ruble (XRU) was launched at the end of last year and has drawn little interest. It boasts a lowly $5 million market cap (assets under management).
Girth Not Size
Political scientists often argue that one of the characteristics of power is that it is concordant. By that they essentially mean that by having one element of power, say economic prowess, one can achieve other elements of power, such as like cultural influence. And yet during the Cold War, Russia’s claim to world power relied almost exclusively on one element—its military might. Power is surely multi-dimensional, but one of the common characteristics of the BRICs are that their power is limited in breadth and depth.
Each of the BRICs has amassed a large level of reserves. Brazil has the least at about $205 billion, just below India’s $251 billion. Russia has almost as much as both of them put together with almost $410 billion. China dwarfs all of them, individually and collectively, with nearly $2 trillion in reserves. Together they account for a third of the world’s currency reserves.
Yet there is no reason to consider them as a unitary whole or that they will act in concert. To the contrary, they each seem to embrace their reserves differently. India seems to regard its reserves most traditionally; an insurance against future calamities. Brazil is more willing to use reserves for domestic purposes and operates in the foreign exchange market daily. Given that Russia defaulted a decade ago, it is little wonder that its large reserves, a third of GDP, are a sign of national pride. The run-down in reserves during the last five months of 2008 was more politically embarrassing than threatening from an economic point of view.
China’s massive reserves, more than a quarter of the world’s reserves, are as much a sign of its successes as its failures. Reserves accumulate as a function of China’s large trade surplus. Rather than increase the share of consumption in GDP, China’s own figures show that it has fallen. China remains reliant on exports. Reserves accumulate as the central bank absorbs some of the hot money coming into the country so as to neutralize its effect. Reserves also accumulate as China manages its exchange rate.
IMF Bonds
The BRICs appear to be under-presented in the International Monetary Fund. As we have seen they account for about 12% of the world economy and yet have a combined quota (vote) of 9.82%. Yet the representation is not as straight-forward as that. Consider that the US accounts for a quarter of the world’s economy and yet the US has a 16.77% weighted vote at the IMF.
The April G20 meeting resolved to raise more funds for the IMF. Some countries like Japan have lent the IMF money. The BRICs want to provide their funds in the form of SDR (Special Drawing Right) bonds. This dovetails nicely with their call to increase the use of the SDR.
Some esteemed money managers are reading into this a grave signal. According to Bloomberg reports, Mark Mobius, executive chairman of Templeton Asset Management, sees the desire for SDR bonds as a rebuke of US fiscal policy. Mohamed El-Erian, CEO of PIMCO, sees the purchases as evidence of accelerating rebalancing of the world economy.
But, it does not seem that it is about us as in the US, but rather about these countries trying to bolster their own prestige and gravitas by contributing to the IMF. It is a function of the wealth they have already attained (reserve accumulation), but says nothing about the challenges that lie ahead. Moreover, the moves are largely symbolic. The $10 billion worth of SDR bonds that Russia is going to procure is 2.5% of its reserves. The $50 billion China will provide is about 2.5% of its reserves as well. Russia is thus far the only BRIC to suggest it will purchase the SDR bonds with its Treasury holdings, which stood at about $138 billion at the end of March, according to US Treasury data. It does not amount to noteworthy diversification of reserves. Nor does it represent much of a diversification away from the dollar as the greenback accounts for 44% of an SDR-basket. The contribution that Japan is committed to is greater than all the BRICs combined. Although noticeably quiet on the subject, India is expected to provide $10 billion to the IMF.
Still an SDR bond market is innovative insofar as one does not exist at the moment. The IMF is expected to announce details later this month or next month. Rather than have to sell US Treasuries there has been some suggestion that the interested countries, which are likely to extend beyond the BRICs, may swap the Treasuries for the SDR bonds, minimizing any market impact. A newly formed SDR bond market will lack the breadth and depth to truly compete with the US Treasury market, though it might have some novelty appeal. The impact on the dollar will likely be marginal at best. An SDR bond market does not mean the SDR is a viable alternative to the dollar or is any closer to being the supra-sovereign reserve asset that some imagine.
I have two asides to this story that are unrelated to the main content.
The first has to do with Brown Brothers Harriman whose research I frequently cite. Visit their FX site here. I suggest you bookmark it. BBH is one of those smaller boutique not publicly traded companies on Wall Street (History here at Wikipedia). How many BBHs are going bankrupt? How many Lazards are feeding at the public trough asking for government handouts? You know the answer – zero. And it is no coincidence. These private companies and partnerships like Greenhill have a much different corporate governance ethos than the likes of Citigroup or Bank of America. Perhaps had Lehman, Goldman and Morgan Stanley remained partnerships, they would have been more prudent in their risk taking.
My second aside has to do with the term CRIBS. I like the moniker. But being the pop culture hound that I am, I couldn’t help but think of that MTV show called MTV Cribs where the likes of Shaquille O’Neal or Robbie Williams gives us a glimpse of how rich and successful they are. When Peter Schiff was on the Daily Show recently, Jon Stewart sarcastically rebutted Schiff by suggesting his America-as-an-indebted-Banana-Republic meme would mean an end to culturally enriching shows like MTV Cribs. I’ve attached the video below for your amusement.
And, for the record, despite my snarky remarks, I like the show Cribs. Very entertaining.
The biggest bill in history
--Massive public debt is weighing on developed countries. Public debt in top ten rich countries will rise from 78% of GDP to 114% in 2014. By 2050, one third of world population will be over sixty. Demographic bill will large.
--Fiscal laxity by borrowing will pull the sagging economy out of ditch, but it is unstainable. It will crowd out private investment, spur inflation, and lead to more defaults.
--A fit of fiscal auterity by hiking tax rates will probably stymie economic growth as what happend in Japan in 1997
--The right way is the commitment to reduce deficits and instute rules to reinforce the political resolve.
Jun 11th 2009
From The Economist print edition
The right and wrong ways to deal with the rich world’s fiscal mess
Brett Ryder
THE worst global economic storm since the 1930s may be beginning to clear, but another cloud already looms on the financial horizon: massive public debt. Across the rich world governments are borrowing vast amounts as the recession reduces tax revenue and spending mounts—on bail-outs, unemployment benefits and stimulus plans. New figures from economists at the IMF suggest that the public debt of the ten leading rich countries will rise from 78% of GDP in 2007 to 114% by 2014. These governments will then owe around $50,000 for every one of their citizens (see article).
Not since the second world war have so many governments borrowed so much so quickly or, collectively, been so heavily in hock. And today’s debt surge, unlike the wartime one, will not be temporary. Even after the recession ends few rich countries will be running budgets tight enough to stop their debt from rising further. Worse, today’s borrowing binge is taking place just before a slow-motion budget-bust caused by the pension and health-care costs of a greying population. By 2050 a third of the rich world’s population will be over 60. The demographic bill is likely to be ten times bigger than the fiscal cost of the financial crisis.
Will they default, inflate or manage their way out?
This alarming trajectory puts policymakers in an increasingly tricky bind. In the short term government borrowing is an essential antidote to the slump. Without bank bail-outs the financial crash would have been even more of a catastrophe. Without stimulus the global recession would be deeper and longer—and it is a prolonged downturn that does the greatest damage to public finances. But in the long run today’s fiscal laxity is unsustainable. Governments’ thirst for funds will eventually crowd out private investment and reduce economic growth. More alarming, the scale of the coming indebtedness might ultimately induce governments to default or to cut the real cost of their debt through high inflation.
Investors have been fretting on both counts. Worries about default have been focused on weaker countries in the euro area, particularly Greece, Ireland, Italy, Portugal and Spain, where the single currency removes the option of unilateral inflation (see our special report). Ireland’s debt was downgraded for a second time on June 8th. Fears of inflation have concentrated on America, where yields on ten-year Treasuries reached nearly 4% on June 10th; in December the figure was not much above 2%. Much of this rise stems from confidence about economic recovery rather than fiscal alarm. Yet eye-popping deficits and the uncharted nature of today’s monetary policy, with the Federal Reserve (like the Bank of England) printing money to buy government bonds, are prompting concerns that America’s debt might eventually be inflated away.
Justified or not, such worries will themselves wreak damage. The economic recovery could be stillborn if interest rates rise too far too fast. And today’s policy remedies could become increasingly ineffective. Printing more money to buy government debt, for instance, might send long-term bond yields higher rather than lower.
What should policymakers do? A sudden fit of fiscal austerity would be a mistake. Even when economies stop shrinking, they will stay weak. Japan’s experience in 1997, when a rise in consumption taxes pushed the economy back into recession, is a reminder that a rush to fiscal tightening is counterproductive, especially after a banking bust. Instead of slashing their deficits now, the rich world’s governments need to promise, credibly, that they will do so once their economies are stronger.
Lord, make me prudent—but not yet
But how? Politicians’ promises are not worth much by themselves. Any commitment to prudence must include clear principles on how deficits will be shrunk; new rules to stiffen politicians’ spines; and quick action on politically difficult measures that would yield future savings without denting demand much today, such as raising the retirement age.
Broadly, governments should pledge to clean up their public finances by cutting future spending rather than raising taxes. Most European countries have scant room for higher taxes. In several, the government already hoovers up well over 40% of GDP. Tax reform will be necessary—particularly in places, such as Britain and Ireland, which relied far too much on revenues from frothy financial markets and housing bubbles. Even in the United States, where tax revenues add up to less than 30% of GDP, simply raising tax rates is not the best answer. There too, spending control should take priority, though there is certainly room for efficiency-enhancing tax reforms, such as eliminating the preferential tax treatment of housing and the deductibility of employer-provided health insurance.
The next step is to boost the credibility of these principles with rules and institutions to reinforce future politicians’ resolve. Britain’s Conservative Party cleverly wants to create an independent “Office for Budgetary Responsibility” to give an impartial assessment of the government’s plans. Germany is poised to pass a constitutional amendment limiting its structural budget deficit to 0.35% of GDP from 2016. Barack Obama’s team wants to resurrect deficit-control rules (see article). Such corsets need to be carefully designed—and Germany’s may prove too rigid. But experience from Chile to Switzerland suggests that the right budgetary girdles can restrain profligacy.
Yet nothing sends a stronger signal than taking difficult decisions today. One priority is to raise the retirement age, which would boost tax revenues (as people work longer) and cut future pension costs. Many rich countries are already doing this, but they need to go further and faster. Another huge target is health care. America has the most wasteful system on the planet. Its fiscal future would be transformed if Congress passed reforms that emphasised control of costs as much as the expansion of coverage that Barack Obama rightly wants.
All this is a tall order. Politicians have failed to control the costs of ageing populations for years. Paradoxically, the financial bust, by adding so much debt, may boost the chances of a breakthrough. If not, another financial catastrophe looms.
--Fiscal laxity by borrowing will pull the sagging economy out of ditch, but it is unstainable. It will crowd out private investment, spur inflation, and lead to more defaults.
--A fit of fiscal auterity by hiking tax rates will probably stymie economic growth as what happend in Japan in 1997
--The right way is the commitment to reduce deficits and instute rules to reinforce the political resolve.
Jun 11th 2009
From The Economist print edition
The right and wrong ways to deal with the rich world’s fiscal mess
Brett Ryder
THE worst global economic storm since the 1930s may be beginning to clear, but another cloud already looms on the financial horizon: massive public debt. Across the rich world governments are borrowing vast amounts as the recession reduces tax revenue and spending mounts—on bail-outs, unemployment benefits and stimulus plans. New figures from economists at the IMF suggest that the public debt of the ten leading rich countries will rise from 78% of GDP in 2007 to 114% by 2014. These governments will then owe around $50,000 for every one of their citizens (see article).
Not since the second world war have so many governments borrowed so much so quickly or, collectively, been so heavily in hock. And today’s debt surge, unlike the wartime one, will not be temporary. Even after the recession ends few rich countries will be running budgets tight enough to stop their debt from rising further. Worse, today’s borrowing binge is taking place just before a slow-motion budget-bust caused by the pension and health-care costs of a greying population. By 2050 a third of the rich world’s population will be over 60. The demographic bill is likely to be ten times bigger than the fiscal cost of the financial crisis.
Will they default, inflate or manage their way out?
This alarming trajectory puts policymakers in an increasingly tricky bind. In the short term government borrowing is an essential antidote to the slump. Without bank bail-outs the financial crash would have been even more of a catastrophe. Without stimulus the global recession would be deeper and longer—and it is a prolonged downturn that does the greatest damage to public finances. But in the long run today’s fiscal laxity is unsustainable. Governments’ thirst for funds will eventually crowd out private investment and reduce economic growth. More alarming, the scale of the coming indebtedness might ultimately induce governments to default or to cut the real cost of their debt through high inflation.
Investors have been fretting on both counts. Worries about default have been focused on weaker countries in the euro area, particularly Greece, Ireland, Italy, Portugal and Spain, where the single currency removes the option of unilateral inflation (see our special report). Ireland’s debt was downgraded for a second time on June 8th. Fears of inflation have concentrated on America, where yields on ten-year Treasuries reached nearly 4% on June 10th; in December the figure was not much above 2%. Much of this rise stems from confidence about economic recovery rather than fiscal alarm. Yet eye-popping deficits and the uncharted nature of today’s monetary policy, with the Federal Reserve (like the Bank of England) printing money to buy government bonds, are prompting concerns that America’s debt might eventually be inflated away.
Justified or not, such worries will themselves wreak damage. The economic recovery could be stillborn if interest rates rise too far too fast. And today’s policy remedies could become increasingly ineffective. Printing more money to buy government debt, for instance, might send long-term bond yields higher rather than lower.
What should policymakers do? A sudden fit of fiscal austerity would be a mistake. Even when economies stop shrinking, they will stay weak. Japan’s experience in 1997, when a rise in consumption taxes pushed the economy back into recession, is a reminder that a rush to fiscal tightening is counterproductive, especially after a banking bust. Instead of slashing their deficits now, the rich world’s governments need to promise, credibly, that they will do so once their economies are stronger.
Lord, make me prudent—but not yet
But how? Politicians’ promises are not worth much by themselves. Any commitment to prudence must include clear principles on how deficits will be shrunk; new rules to stiffen politicians’ spines; and quick action on politically difficult measures that would yield future savings without denting demand much today, such as raising the retirement age.
Broadly, governments should pledge to clean up their public finances by cutting future spending rather than raising taxes. Most European countries have scant room for higher taxes. In several, the government already hoovers up well over 40% of GDP. Tax reform will be necessary—particularly in places, such as Britain and Ireland, which relied far too much on revenues from frothy financial markets and housing bubbles. Even in the United States, where tax revenues add up to less than 30% of GDP, simply raising tax rates is not the best answer. There too, spending control should take priority, though there is certainly room for efficiency-enhancing tax reforms, such as eliminating the preferential tax treatment of housing and the deductibility of employer-provided health insurance.
The next step is to boost the credibility of these principles with rules and institutions to reinforce future politicians’ resolve. Britain’s Conservative Party cleverly wants to create an independent “Office for Budgetary Responsibility” to give an impartial assessment of the government’s plans. Germany is poised to pass a constitutional amendment limiting its structural budget deficit to 0.35% of GDP from 2016. Barack Obama’s team wants to resurrect deficit-control rules (see article). Such corsets need to be carefully designed—and Germany’s may prove too rigid. But experience from Chile to Switzerland suggests that the right budgetary girdles can restrain profligacy.
Yet nothing sends a stronger signal than taking difficult decisions today. One priority is to raise the retirement age, which would boost tax revenues (as people work longer) and cut future pension costs. Many rich countries are already doing this, but they need to go further and faster. Another huge target is health care. America has the most wasteful system on the planet. Its fiscal future would be transformed if Congress passed reforms that emphasised control of costs as much as the expansion of coverage that Barack Obama rightly wants.
All this is a tall order. Politicians have failed to control the costs of ageing populations for years. Paradoxically, the financial bust, by adding so much debt, may boost the chances of a breakthrough. If not, another financial catastrophe looms.
Friday, June 12, 2009
Fed to Keep Lid on Bond Buys
By JON HILSENRATH
WASHINGTON -- Federal Reserve officials are unlikely to significantly boost purchases of U.S. Treasurys and mortgage-backed securities when they meet in late June, but could make other adjustments in the face of rising bond yields and fresh signs of an improving economy.
Fed officials have become more confident recently that they have stabilized the economy and set the stage for recovery. But divisions are brewing within the Fed over whether it should do more to speed the healing, pause, or start pulling back to avoid an outbreak of inflation.
Those crosscurrents are likely to inhibit bold new strokes by the Fed at its next meeting, in contrast to earlier in the year, when a bleak outlook spurred aggressive action.
The Fed's bond-purchase programs are designed to drive up Treasury prices and push down interest rates across the economy. The bond and mortgage-debt purchases have been at the center of the government's efforts to jump-start economic activity.
But as bond yields and mortgage rates rise, the Fed is struggling to gauge the effect of its buying and to decide how to proceed.
Yields on 10-year Treasury notes fell Thursday to 3.862%, after Wednesday's brush with 4%. But they remain sharply higher than March's 2.5% -- a potential threat to economic recovery. Solid demand at a government auction of 30-year Treasury bonds bolstered the bond market on Thursday.
Interest rates on everything from business loans to home mortgages tend to move in tandem with Treasury rates. If government-bond rates rise too much too fast, they could short-circuit a recovery by choking off consumer and business borrowing and spending.
Fed officials aren't convinced that is happening yet, so they aren't inclined to use their muscle to restrain bond yields any more than they have already set out to do. That could change if their views of markets and the economy change. Fed officials say much needs to be hashed out at the next meeting.
When officials convene on June 23 and 24 in Washington, one idea on the table will be to stretch out over a longer period of time planned purchases of Treasury securities or mortgage-backed securities. Doing so would avoid an abrupt, and perhaps disruptive, end to the buying and give the Fed time to assess the outlook. The Treasury has set out to buy $300 billion of Treasurys by the end of August. It is on a path to buy $1.25 trillion of mortgage-backed securities by the end of this year or early next year.
So far, the Fed has purchased $156.5 billion of government bonds. Officials could also change the mix of their purchases.
Despite the recent rise in mortgage rates, officials are reluctant to increase their planned purchases of mortgage-backed securities, which would tend to push down such rates. The Fed already has bought $555.9 billion of mortgage securities. Officials worry that increased buying would make the Fed too dominant in the market, deterring other investors from participating or causing big price distortions. The rate on 30-year fixed-rate mortgages climbed to 5.81% on Thursday, from 5% two weeks ago, according to HSH Associates.
The five current Fed governors in Washington and the presidents of the 12 regional Fed banks intend to discuss at their June meeting how to manage their exit from their unconventional monetary policy, when the time comes. One worry is that if they buy too many securities now, it will be hard to unwind their programs later.
Inside the Fed, several officials still believe that even if growth resumes, the economy will need more stimulus from the central bank because the unemployment rate is likely to remain above 9% for years and factories are still running far below capacity.
Fed Chairman Ben Bernanke and others have argued the economic slack puts downward pressure on inflation.
"This is not an environment in which inflationary pressures are at all likely for some time to come," former Fed Chairman Paul Volcker, who made his name as an inflation fighter, said in a speech in Beijing Thursday.
Still, some Fed officials worry that if they wait too long to reverse the tidal wave of money they've pumped into the financial system, that could spark inflation -- a threat that bond markets might already be signaling by pushing up Treasury yields. "Just as there is slack, there is also an enormous amount of stimulus in the economy and coming into the economy," said Kansas City Fed President Thomas Hoenig in an interview. "Being too slow to remove our expansionary actions would very likely be inflationary."
The Fed's task is complicated by the fact that it is using tools it has never used before. It has already cut the interest rate that banks charge each other on overnight loans -- once its primary economic-stimulus tool -- to zero, and it has vowed to keep it there for a while. It has also turned to bond buying and targeted lending.
Another challenge on the June agenda is how to communicate Fed thinking about the complex set of "crosscurrents," as one official describes it. Fed officials believe markets may have gotten ahead of the economy, reacting to government data that the pace of job losses is slowing by anticipating an increase in the Fed's key short-term interest rates by year end. Some Fed officials see that as an overreaction.
Even inside the Fed, officials find it hard to measure the effect of their unconventional policies and to decide how much bond buying is needed. Some research suggests that $100 billion of Treasury securities purchases results in interests rates falling 0.05 to 0.08 percentage points. But many top Fed officials have little confidence in such projections.
In a Wall Street Journal survey released Thursday, 35 of the 50 Wall Street economists who responded, or 70%, said the Fed shouldn't increase its planned purchases of Treasurys. Some 64% said Treasury yields are rising because the economy is improving, and because investors are becoming less risk-averse and moving away from safe government bonds to riskier corporate debt and other securities. Most of those surveyed don't expect the Fed to raise short-term interest rates before the second quarter of 2010.
Recently, the market has focused on government borrowing and the size of the deficit. Some officials worry that buying more government bonds could signal the Fed's willingness to accommodate large budget deficits. That could be inflationary, and could lead the bond market to push yields even higher. "The main danger of a Treasury purchase program is that people may wrongfully conclude that there is a risk that you are going to monetize the debt and reinflate," said William Dudley, president of the New York Fed, in an interview. Initially he was wary of the program, he said, but he became less so in March after the Bank of England announced a similar plan that didn't spook investors.
Fed officials have been admonishing lawmakers to do more to restrain the deficit. Higher yields on Treasurys "can be seen as an expression of creeping doubt that the American polity, and more specifically the policy community, is up to the sacrifices, trade-off decisions, and the courage of convictions the situation requires," said Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, in a speech Thursday.
Many officials believe bond yields are rising now because investors are shifting from low-risk securities such as Treasurys to higher-risk ones such as corporate bonds, a sign of improving confidence in markets. They also believe investors are less worried about an even deeper downturn that would cause deflation, a dangerous downward spiral in consumer prices.
Fed officials take comfort in other developments in financial markets. Though mortgage rates have risen, many other private-sector borrowing rates are coming down. For example, the London interbank offered rate -- the rate at which banks make short-term loans to one another -- has declined. Rising stock prices are also helping improve financial conditions and bolster household wealth.
"Conditions in a number of financial markets have improved since earlier this year," Mr. Bernanke said last week in testimony to Congress.
Write to Jon Hilsenrath at jon.hilsenrath@wsj.com
WASHINGTON -- Federal Reserve officials are unlikely to significantly boost purchases of U.S. Treasurys and mortgage-backed securities when they meet in late June, but could make other adjustments in the face of rising bond yields and fresh signs of an improving economy.
Fed officials have become more confident recently that they have stabilized the economy and set the stage for recovery. But divisions are brewing within the Fed over whether it should do more to speed the healing, pause, or start pulling back to avoid an outbreak of inflation.
Those crosscurrents are likely to inhibit bold new strokes by the Fed at its next meeting, in contrast to earlier in the year, when a bleak outlook spurred aggressive action.
The Fed's bond-purchase programs are designed to drive up Treasury prices and push down interest rates across the economy. The bond and mortgage-debt purchases have been at the center of the government's efforts to jump-start economic activity.
But as bond yields and mortgage rates rise, the Fed is struggling to gauge the effect of its buying and to decide how to proceed.
Yields on 10-year Treasury notes fell Thursday to 3.862%, after Wednesday's brush with 4%. But they remain sharply higher than March's 2.5% -- a potential threat to economic recovery. Solid demand at a government auction of 30-year Treasury bonds bolstered the bond market on Thursday.
Interest rates on everything from business loans to home mortgages tend to move in tandem with Treasury rates. If government-bond rates rise too much too fast, they could short-circuit a recovery by choking off consumer and business borrowing and spending.
Fed officials aren't convinced that is happening yet, so they aren't inclined to use their muscle to restrain bond yields any more than they have already set out to do. That could change if their views of markets and the economy change. Fed officials say much needs to be hashed out at the next meeting.
When officials convene on June 23 and 24 in Washington, one idea on the table will be to stretch out over a longer period of time planned purchases of Treasury securities or mortgage-backed securities. Doing so would avoid an abrupt, and perhaps disruptive, end to the buying and give the Fed time to assess the outlook. The Treasury has set out to buy $300 billion of Treasurys by the end of August. It is on a path to buy $1.25 trillion of mortgage-backed securities by the end of this year or early next year.
So far, the Fed has purchased $156.5 billion of government bonds. Officials could also change the mix of their purchases.
Despite the recent rise in mortgage rates, officials are reluctant to increase their planned purchases of mortgage-backed securities, which would tend to push down such rates. The Fed already has bought $555.9 billion of mortgage securities. Officials worry that increased buying would make the Fed too dominant in the market, deterring other investors from participating or causing big price distortions. The rate on 30-year fixed-rate mortgages climbed to 5.81% on Thursday, from 5% two weeks ago, according to HSH Associates.
The five current Fed governors in Washington and the presidents of the 12 regional Fed banks intend to discuss at their June meeting how to manage their exit from their unconventional monetary policy, when the time comes. One worry is that if they buy too many securities now, it will be hard to unwind their programs later.
Inside the Fed, several officials still believe that even if growth resumes, the economy will need more stimulus from the central bank because the unemployment rate is likely to remain above 9% for years and factories are still running far below capacity.
Fed Chairman Ben Bernanke and others have argued the economic slack puts downward pressure on inflation.
"This is not an environment in which inflationary pressures are at all likely for some time to come," former Fed Chairman Paul Volcker, who made his name as an inflation fighter, said in a speech in Beijing Thursday.
Still, some Fed officials worry that if they wait too long to reverse the tidal wave of money they've pumped into the financial system, that could spark inflation -- a threat that bond markets might already be signaling by pushing up Treasury yields. "Just as there is slack, there is also an enormous amount of stimulus in the economy and coming into the economy," said Kansas City Fed President Thomas Hoenig in an interview. "Being too slow to remove our expansionary actions would very likely be inflationary."
The Fed's task is complicated by the fact that it is using tools it has never used before. It has already cut the interest rate that banks charge each other on overnight loans -- once its primary economic-stimulus tool -- to zero, and it has vowed to keep it there for a while. It has also turned to bond buying and targeted lending.
Another challenge on the June agenda is how to communicate Fed thinking about the complex set of "crosscurrents," as one official describes it. Fed officials believe markets may have gotten ahead of the economy, reacting to government data that the pace of job losses is slowing by anticipating an increase in the Fed's key short-term interest rates by year end. Some Fed officials see that as an overreaction.
Even inside the Fed, officials find it hard to measure the effect of their unconventional policies and to decide how much bond buying is needed. Some research suggests that $100 billion of Treasury securities purchases results in interests rates falling 0.05 to 0.08 percentage points. But many top Fed officials have little confidence in such projections.
In a Wall Street Journal survey released Thursday, 35 of the 50 Wall Street economists who responded, or 70%, said the Fed shouldn't increase its planned purchases of Treasurys. Some 64% said Treasury yields are rising because the economy is improving, and because investors are becoming less risk-averse and moving away from safe government bonds to riskier corporate debt and other securities. Most of those surveyed don't expect the Fed to raise short-term interest rates before the second quarter of 2010.
Recently, the market has focused on government borrowing and the size of the deficit. Some officials worry that buying more government bonds could signal the Fed's willingness to accommodate large budget deficits. That could be inflationary, and could lead the bond market to push yields even higher. "The main danger of a Treasury purchase program is that people may wrongfully conclude that there is a risk that you are going to monetize the debt and reinflate," said William Dudley, president of the New York Fed, in an interview. Initially he was wary of the program, he said, but he became less so in March after the Bank of England announced a similar plan that didn't spook investors.
Fed officials have been admonishing lawmakers to do more to restrain the deficit. Higher yields on Treasurys "can be seen as an expression of creeping doubt that the American polity, and more specifically the policy community, is up to the sacrifices, trade-off decisions, and the courage of convictions the situation requires," said Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, in a speech Thursday.
Many officials believe bond yields are rising now because investors are shifting from low-risk securities such as Treasurys to higher-risk ones such as corporate bonds, a sign of improving confidence in markets. They also believe investors are less worried about an even deeper downturn that would cause deflation, a dangerous downward spiral in consumer prices.
Fed officials take comfort in other developments in financial markets. Though mortgage rates have risen, many other private-sector borrowing rates are coming down. For example, the London interbank offered rate -- the rate at which banks make short-term loans to one another -- has declined. Rising stock prices are also helping improve financial conditions and bolster household wealth.
"Conditions in a number of financial markets have improved since earlier this year," Mr. Bernanke said last week in testimony to Congress.
Write to Jon Hilsenrath at jon.hilsenrath@wsj.com
Thursday, June 11, 2009
MGM Mirage Weighs Business Alliance With Malaysian Casino Owner Genting
By TAMARA AUDI
Las Vegas-based gambling giant MGM Mirage and Malaysian gambling concern Genting Bhd. are discussing a broad range of business partnerships in the global gambling industry, MGM Mirage Chief Executive Jim Murren said Thursday.
Any partnership could give Genting access to lucrative business in Macau, China's gambling enclave where MGM operates, and offer MGM Mirage entree into other regions of Asia where Genting has a major presence.
Genting recently invested $200 million in MGM Mirage, with half of the amount for a 3.2% equity stake and half on a bond issue. Mr. Murren said officials from the two companies have had a long relationship, and are interested in working together on a variety of projects world-wide.
"We're just starting to brainstorm about global marketing relationships, strategic ventures and partnerships," Mr. Murren said. A relationship with Genting "in particular holds great interest to me because they are so great at what they do. I think there's a commonality of philosophy. ...It's a very powerful potential alliance."
"We are constantly looking to broaden our portfolio of strategic investments and strengthening our partnerships around the world," said Justin Leong, head of strategic investments and corporate affairs for Genting Bhd. "We have had a variety of discussions with MGM but they are still at an early stage," he added. "We hold MGM in the highest regard -- they really are one of the icons of the gaming industry. We look forward to further discussions with MGM."
Genting dominates the gambling industry in Malaysia and plans to open a casino resort in Singapore next year. MGM Mirage dominates the Las Vegas Strip with prominent properties like the Bellagio and the Mirage. It also operates an MGM Grand in China's gambling enclave of Macau, considered the most lucrative gambling market in the world.
"We have no overlap of business and we have a very similar approach to business," Mr. Murren said of Genting.
In the past, MGM Mirage has struck joint-venture partnerships with real-estate developers and other casino operators. In Connecticut, for example, MGM Mirage struck a licensing deal with the Mashantucket Pequot Indian tribe, which built an MGM Grand as part of its Foxwoods casino resort. In New Jersey, MGM Mirage owns half of the Borgata casino as part of a deal with Boyd Gaming Corp. MGM Mirage recently launched a separate hotel division and has struck deals with developers to spread the MGM Grand and Bellagio brands around the world.
Industry observers speculated that Genting is interested in buying MGM Mirage's stake in the Macau casino, which it operates in partnership with Pansy Ho, the daughter of Chinese gambling magnate Stanley Ho. Ms. Ho was recently declared an "unsuitable" partner for MGM Mirage by New Jersey gambling regulators, potentially jeopardizing MGM Mirage's ability to operate in that state.
Were Genting to purchase MGM Mirage's stake in the Macau casino, that would resolve any issue with New Jersey gambling regulators. Mr. Murren said that option "was never even discussed" by the two companies. However, he did not rule it out.
Mr. Murren said MGM Mirage will "explore all our options in Macau" in light of the New Jersey gambling report on Ms. Ho. "We do want to be in Macau under the right circumstances."
He said the company's casino is "underperforming" in Macau. "We need to make more money there and be more successful there."
—Jonathan Cheng contributed to this article.
Write to Tamara Audi at tammy.audi@wsj.com
Las Vegas-based gambling giant MGM Mirage and Malaysian gambling concern Genting Bhd. are discussing a broad range of business partnerships in the global gambling industry, MGM Mirage Chief Executive Jim Murren said Thursday.
Any partnership could give Genting access to lucrative business in Macau, China's gambling enclave where MGM operates, and offer MGM Mirage entree into other regions of Asia where Genting has a major presence.
Genting recently invested $200 million in MGM Mirage, with half of the amount for a 3.2% equity stake and half on a bond issue. Mr. Murren said officials from the two companies have had a long relationship, and are interested in working together on a variety of projects world-wide.
"We're just starting to brainstorm about global marketing relationships, strategic ventures and partnerships," Mr. Murren said. A relationship with Genting "in particular holds great interest to me because they are so great at what they do. I think there's a commonality of philosophy. ...It's a very powerful potential alliance."
"We are constantly looking to broaden our portfolio of strategic investments and strengthening our partnerships around the world," said Justin Leong, head of strategic investments and corporate affairs for Genting Bhd. "We have had a variety of discussions with MGM but they are still at an early stage," he added. "We hold MGM in the highest regard -- they really are one of the icons of the gaming industry. We look forward to further discussions with MGM."
Genting dominates the gambling industry in Malaysia and plans to open a casino resort in Singapore next year. MGM Mirage dominates the Las Vegas Strip with prominent properties like the Bellagio and the Mirage. It also operates an MGM Grand in China's gambling enclave of Macau, considered the most lucrative gambling market in the world.
"We have no overlap of business and we have a very similar approach to business," Mr. Murren said of Genting.
In the past, MGM Mirage has struck joint-venture partnerships with real-estate developers and other casino operators. In Connecticut, for example, MGM Mirage struck a licensing deal with the Mashantucket Pequot Indian tribe, which built an MGM Grand as part of its Foxwoods casino resort. In New Jersey, MGM Mirage owns half of the Borgata casino as part of a deal with Boyd Gaming Corp. MGM Mirage recently launched a separate hotel division and has struck deals with developers to spread the MGM Grand and Bellagio brands around the world.
Industry observers speculated that Genting is interested in buying MGM Mirage's stake in the Macau casino, which it operates in partnership with Pansy Ho, the daughter of Chinese gambling magnate Stanley Ho. Ms. Ho was recently declared an "unsuitable" partner for MGM Mirage by New Jersey gambling regulators, potentially jeopardizing MGM Mirage's ability to operate in that state.
Were Genting to purchase MGM Mirage's stake in the Macau casino, that would resolve any issue with New Jersey gambling regulators. Mr. Murren said that option "was never even discussed" by the two companies. However, he did not rule it out.
Mr. Murren said MGM Mirage will "explore all our options in Macau" in light of the New Jersey gambling report on Ms. Ho. "We do want to be in Macau under the right circumstances."
He said the company's casino is "underperforming" in Macau. "We need to make more money there and be more successful there."
—Jonathan Cheng contributed to this article.
Write to Tamara Audi at tammy.audi@wsj.com
BlackRock About to Be No. 1 Money Firm
Fink's Company, Combined with Barclays's Unit, Would Be Largest at $2.8 Trillion in Assets
By ELEANOR LAISE
One of the money-management business's rare successful acquirers is on the brink of its biggest deal ever.
An expected deal in which BlackRock Inc. would buy indexing company Barclays Global Investors from British bank Barclays PLC is likely to be announced as early as Thursday, according to people close to the matter. The New York money manager is expected to pay about $13 billion for the asset-management unit, and Barclays could retain about a 20% stake.
The deal also could give Barclays a seat on BlackRock's board. BlackRock is expected to fund a portion of the purchase from sovereign funds in the Middle East.
Combined with BGI, BlackRock would be the world's largest money manager, with roughly $2.8 trillion in assets under management. That is about eight times the assets BlackRock had in 2004, before it embarked on a series of deals that helped assets under management leap to $1.3 trillion by the end of last year.
The BlackRock deal could portend more consolidation in the asset-management business, which has been hit hard by a combination of declining stock prices and investor withdrawals. Profits have shrunk, and many fund companies are trying to build broad product lineups to hold on to investor dollars. BlackRock's stock has jumped 9% this week as talk of a potential deal intensified.
Though asset-management industry mergers and acquisitions have a spotty track record, BlackRock has fueled much of its growth in recent years with a string of deals. Yet a BlackRock-BGI combination isn't without risks. Analysts wonder whether such a large money manager has much room to expand, and whether BGI's specialty, index-tracking products, fits well under one roof with BlackRock's active management expertise.
Biggest Managers
Money managers ranked by world-wide assets. Assets in trillions, as of Dec. 31, 2008*
Manager Assets
Barclays Global $1.5
State Street Global 1.4
Fidelity Investments 1.4
BlackRock 1.3
Vanguard Group 1.1
J.P. Morgan Asset Mgt. 1.1
BNY Mellon Asset Mgt. 0.9
Goldman Sachs 0.8
Pimco 0.7
Legg Mason 0.7
*managing assets for U.S.-based, institutional, tax-exempt investors
Source: Pensions & Investments
Laurence Fink founded BlackRock in 1988 and has overseen its growth from a firm with $1 billion in assets under management to one of the industry's biggest players. Though much of the growth came through BlackRock's reputation as a strong institutional bond manager, in recent years the firm also has raked in assets by going on a shopping spree. The company bought SSRM Holdings Inc., which owns State Street Research & Management, in 2005, merged with Merrill Lynch Investment Managers in 2006, and acquired the funds-of-funds business of Quellos Group LLC in 2007.
The string of deals helped BlackRock reinvent itself with a more diversified mix of stock and bond funds. The State Street and Merrill Lynch deals did much to expand BlackRock's U.S. mutual-fund business and stock-product lineup. The Merrill deal helped BlackRock boost product distribution around the world. The deal also more than doubled BlackRock's assets under management, to about $1 trillion.
BlackRock's relatively smooth integration of these businesses is unusual in asset-management industry mergers. The deals are often hard to pull off, industry observers said, because success depends largely on managers who often come from different corporate cultures and don't always have strong incentives to stick around. And bigger deals aren't necessarily better. Merrill Lynch's 1998 acquisition of Mercury Asset Management, the biggest money-management deal at the time, ran into troubles, such as investment-personnel defections.
But BlackRock tends to take "a very thoughtful and calculated" approach to deals, said Michael Herbst, mutual-fund analyst at investment-research firm Morningstar Inc. The Merrill Lynch deal worked out well for fund shareholders, in part, because BlackRock helped the Merrill funds bolster stock research and improve risk management, Mr. Herbst said.
The diversified product mix built largely through its recent deals helped BlackRock become one of the few asset-management firms to emerge from the market downturn relatively unscathed.
BlackRock has also become a partner with the government in programs aimed at calming the financial crisis. The firm has helped to analyze the hard-to-price assets of some financial institutions and has applied to be one of a few managers to buy toxic assets from banks as part of the Public-Private Investment Program.
BlackRock is partially owned by Bank of America Corp. and PNC Financial Services Group Inc.
View Full Image
Bloomberg News
In recent months, Mr. Fink has said that he sees smaller asset-management firms struggling in the coming environment of higher regulatory costs and other challenges. On a conference call in April, he pointed to acquisitions as a potential means of boosting the company's presence among individual investors and noted that BlackRock has been flooded with potential deals.
"We have great opportunities to do an acquisition, and we will do what is right for the long term of our platform, what is right for our clients, and what is right for our employees," he said.
But the BGI deal is by no means a slam dunk, industry observers said. It would roughly double BlackRock's assets under management, and there could be challenges digesting such a big acquisition. Such a large asset manager may have trouble executing some trades at favorable prices, because it can easily move the market.
—Sara Schaefer Muñoz contributed to this article.
Write to Eleanor Laise at eleanor.laise@wsj.com
By ELEANOR LAISE
One of the money-management business's rare successful acquirers is on the brink of its biggest deal ever.
An expected deal in which BlackRock Inc. would buy indexing company Barclays Global Investors from British bank Barclays PLC is likely to be announced as early as Thursday, according to people close to the matter. The New York money manager is expected to pay about $13 billion for the asset-management unit, and Barclays could retain about a 20% stake.
The deal also could give Barclays a seat on BlackRock's board. BlackRock is expected to fund a portion of the purchase from sovereign funds in the Middle East.
Combined with BGI, BlackRock would be the world's largest money manager, with roughly $2.8 trillion in assets under management. That is about eight times the assets BlackRock had in 2004, before it embarked on a series of deals that helped assets under management leap to $1.3 trillion by the end of last year.
The BlackRock deal could portend more consolidation in the asset-management business, which has been hit hard by a combination of declining stock prices and investor withdrawals. Profits have shrunk, and many fund companies are trying to build broad product lineups to hold on to investor dollars. BlackRock's stock has jumped 9% this week as talk of a potential deal intensified.
Though asset-management industry mergers and acquisitions have a spotty track record, BlackRock has fueled much of its growth in recent years with a string of deals. Yet a BlackRock-BGI combination isn't without risks. Analysts wonder whether such a large money manager has much room to expand, and whether BGI's specialty, index-tracking products, fits well under one roof with BlackRock's active management expertise.
Biggest Managers
Money managers ranked by world-wide assets. Assets in trillions, as of Dec. 31, 2008*
Manager Assets
Barclays Global $1.5
State Street Global 1.4
Fidelity Investments 1.4
BlackRock 1.3
Vanguard Group 1.1
J.P. Morgan Asset Mgt. 1.1
BNY Mellon Asset Mgt. 0.9
Goldman Sachs 0.8
Pimco 0.7
Legg Mason 0.7
*managing assets for U.S.-based, institutional, tax-exempt investors
Source: Pensions & Investments
Laurence Fink founded BlackRock in 1988 and has overseen its growth from a firm with $1 billion in assets under management to one of the industry's biggest players. Though much of the growth came through BlackRock's reputation as a strong institutional bond manager, in recent years the firm also has raked in assets by going on a shopping spree. The company bought SSRM Holdings Inc., which owns State Street Research & Management, in 2005, merged with Merrill Lynch Investment Managers in 2006, and acquired the funds-of-funds business of Quellos Group LLC in 2007.
The string of deals helped BlackRock reinvent itself with a more diversified mix of stock and bond funds. The State Street and Merrill Lynch deals did much to expand BlackRock's U.S. mutual-fund business and stock-product lineup. The Merrill deal helped BlackRock boost product distribution around the world. The deal also more than doubled BlackRock's assets under management, to about $1 trillion.
BlackRock's relatively smooth integration of these businesses is unusual in asset-management industry mergers. The deals are often hard to pull off, industry observers said, because success depends largely on managers who often come from different corporate cultures and don't always have strong incentives to stick around. And bigger deals aren't necessarily better. Merrill Lynch's 1998 acquisition of Mercury Asset Management, the biggest money-management deal at the time, ran into troubles, such as investment-personnel defections.
But BlackRock tends to take "a very thoughtful and calculated" approach to deals, said Michael Herbst, mutual-fund analyst at investment-research firm Morningstar Inc. The Merrill Lynch deal worked out well for fund shareholders, in part, because BlackRock helped the Merrill funds bolster stock research and improve risk management, Mr. Herbst said.
The diversified product mix built largely through its recent deals helped BlackRock become one of the few asset-management firms to emerge from the market downturn relatively unscathed.
BlackRock has also become a partner with the government in programs aimed at calming the financial crisis. The firm has helped to analyze the hard-to-price assets of some financial institutions and has applied to be one of a few managers to buy toxic assets from banks as part of the Public-Private Investment Program.
BlackRock is partially owned by Bank of America Corp. and PNC Financial Services Group Inc.
View Full Image
Bloomberg News
In recent months, Mr. Fink has said that he sees smaller asset-management firms struggling in the coming environment of higher regulatory costs and other challenges. On a conference call in April, he pointed to acquisitions as a potential means of boosting the company's presence among individual investors and noted that BlackRock has been flooded with potential deals.
"We have great opportunities to do an acquisition, and we will do what is right for the long term of our platform, what is right for our clients, and what is right for our employees," he said.
But the BGI deal is by no means a slam dunk, industry observers said. It would roughly double BlackRock's assets under management, and there could be challenges digesting such a big acquisition. Such a large asset manager may have trouble executing some trades at favorable prices, because it can easily move the market.
—Sara Schaefer Muñoz contributed to this article.
Write to Eleanor Laise at eleanor.laise@wsj.com
A Daring Trade Has Wall Street Seething
Texas Brokerage Firm Outwits the Big Banks in a Mortgage-Related Deal, and Now It's War
By GREGORY ZUCKERMAN, SERENA NG and LIZ RAPPAPORT
A canny trade by a small brokerage firm in two markets at the heart of the financial crisis has left some of the biggest players on Wall Street crying foul.
The trade, by Amherst Holdings of Austin, Texas, was particularly galling to the big banks because it turned what they believed was a sure-fire profit into a loss.
The burned banks include J.P. Morgan Chase & Co., Royal Bank of Scotland Group PLC and Bank of America Corp. Some banks have reached out to two industry trade groups about Amherst's actions, and the groups are reviewing the transaction, according to people familiar with their thinking. "It's all-out warfare" between the banks and Amherst, said a senior banker at one firm that lost money.
At issue is a move by Amherst to boost the price of bonds to avoid paying out on credit-default swaps it had sold. Banks are questioning whether Amherst set them up by selling credit-default swaps and then rendering them worthless.
Amherst says it didn't do anything improper, but took advantage of an opportunity when it emerged. A lawyer reviewed and blessed the strategy for the firm, according to people familiar with the matter.
Privately held Amherst says it acted in good faith trying to limit losses for clients, who had sold credit-default swaps on the securities. "We wouldn't jeopardize our business and reputation by entering into an opportunistic trade knowing what the outcome would be," said Amherst's chief executive, Sean Dobson.
The dispute echoes battles over the largely unregulated credit-default-swap market during last year's financial turmoil. Companies including Morgan Stanley accused investors of using the insurance-like contracts to hurt the value of their shares, creating a panic among other investors and the firms' clients.
In 2007, a group of hedge funds led by Paulson & Co. suspected Bear Stearns of plotting to boost the value of subprime-mortgage securities. At the time, Bear (which was later bought by J.P. Morgan) denied planning to engage in such transactions.
So far the latest dust-up has been all words, in part, bankers say, because they are wary of attracting more regulatory scrutiny at a time when lawmakers are planning major reforms in the largely unregulated derivatives markets, long lucrative for banks. While the banks' combined losses from the trade were in the tens of millions of dollars -- modest by recent standards -- they are the buzz of Wall Street as firms try to prevent a repeat of the episode.
The trade involved credit-default swaps and securities backed by subprime mortgages. The original securities had been sold by Lehman Brothers and were backed by $335 million of subprime mortgages mostly on homes in California made at the housing bubble's peak in 2005, according to the prospectus.
Following a wave of refinancing and defaults, only $29 million of the loans were left outstanding by March 2009, half of which were delinquent or in default, according to a performance report by Moody's Investors Service.
Believing the securities would become worthless, traders at J.P. Morgan bought credit-default swaps over the past year from Amherst, according to people familiar with the matter. Credit-default swaps act like insurance, paying off the buyer if securities are hit by losses. Other banks including RBS Securities, which is the U.S. investment-banking arm of Royal Bank of Scotland, and BofA also bought swaps on the securities from different trading partners.
The banks had to pay up for the protection, similar to a person buying insurance on a beach house just before a hurricane. They paid as much as 80 to 90 cents for every dollar of insurance, the going rate last fall according to dealer quotes, expecting to receive a dollar back when the securities became worthless over the coming months.
Traders can buy credit-default swaps on securities they don't own. At one point, at least $130 million of bets had been made on the performance of around $27 million in securities, according to a person familiar with the matter.
In late April, traders at some banks were shocked to find out from monthly remittance reports that the bonds they had bet against had been paid off in full. Normally an investor can't pay off loans like that but if the amount of outstanding loans falls to less than 10% of the original pool, the servicer -- or company that collects mortgage payments from homeowners and forwards them to investors who own the securities -- can buy them and make bondholders whole.
That's what happened in this case. In April, a servicer called Aurora Loan Services at the behest of Amherst purchased the remaining loans and paid off the bonds.
Although Amherst won't provide specifics and won't comment on its arrangement with Aurora, it doesn't deny that it took this approach. (Aurora says it is a subsidiary of Lehman Brothers Bank, but not part of the Lehman Brothers Holdings bankruptcy filing.)
A spokeswoman for Aurora says these servicer provisions are customary and when rights are exercised it ensures that appropriate requirements are met.
When the bonds got paid off, the swaps became worthless, meaning the banks effectively forfeited what they had paid for the insurance. J.P. Morgan lost millions, while RBS and BofA suffered minimal losses, said people familiar with the matter.
On April 28 representatives of banks including J.P. Morgan, Goldman Sachs Group Inc. and UBS AG's UBS Securities held a conference call to discuss the trade but didn't come to any conclusion, according to people familiar with the matter.
Amherst is the antithesis of the big Wall Street banks. With its Austin headquarters and around 100 employees, the 15-year-old firm has long been a player in the mortgage market, but is now one of the upstarts trying to take business from banks weakened by the credit crisis. The firms has hired bankers, mortgage traders and research analysts who had left banks such as Bear Stearns and UBS, while raising new capital to expand its trading activities.
Since the mortgage securities were valued at just $3 million or so in the market, well below the $27 million they were redeemed for, traders believe Amherst entered into an uneconomic transaction to profit from its swap positions.
Firms that suffered losses as well as some that didn't have brought the trade to the attention of two financial industry groups, the Securities Industry and Financial Markets Association, and the American Securitization Forum, which are considering their concerns, say people familiar with the trade groups' thinking.
Critics of these markets say such conflicts aren't a surprise. In secretive, over-the-counter markets "there are hidden risks and fault lines that don't show up until times of stress or when people are losing money," says Martin Weiss of Weiss Research, an investment consultancy in Jupiter, Fla., not involved in the trade.
Many credit-default swap contracts that were written on subprime mortgage securities over the past three years remain outstanding, and holders could lose out if more bonds are made whole. Deutsche Bank has sent a list, reviewed by The Wall Street Journal, to its clients of more than two dozen other mortgage pools that could see similar moves.
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com, Serena Ng at serena.ng@wsj.com and Liz Rappaport at liz.rappaport@wsj.com
By GREGORY ZUCKERMAN, SERENA NG and LIZ RAPPAPORT
A canny trade by a small brokerage firm in two markets at the heart of the financial crisis has left some of the biggest players on Wall Street crying foul.
The trade, by Amherst Holdings of Austin, Texas, was particularly galling to the big banks because it turned what they believed was a sure-fire profit into a loss.
The burned banks include J.P. Morgan Chase & Co., Royal Bank of Scotland Group PLC and Bank of America Corp. Some banks have reached out to two industry trade groups about Amherst's actions, and the groups are reviewing the transaction, according to people familiar with their thinking. "It's all-out warfare" between the banks and Amherst, said a senior banker at one firm that lost money.
At issue is a move by Amherst to boost the price of bonds to avoid paying out on credit-default swaps it had sold. Banks are questioning whether Amherst set them up by selling credit-default swaps and then rendering them worthless.
Amherst says it didn't do anything improper, but took advantage of an opportunity when it emerged. A lawyer reviewed and blessed the strategy for the firm, according to people familiar with the matter.
Privately held Amherst says it acted in good faith trying to limit losses for clients, who had sold credit-default swaps on the securities. "We wouldn't jeopardize our business and reputation by entering into an opportunistic trade knowing what the outcome would be," said Amherst's chief executive, Sean Dobson.
The dispute echoes battles over the largely unregulated credit-default-swap market during last year's financial turmoil. Companies including Morgan Stanley accused investors of using the insurance-like contracts to hurt the value of their shares, creating a panic among other investors and the firms' clients.
In 2007, a group of hedge funds led by Paulson & Co. suspected Bear Stearns of plotting to boost the value of subprime-mortgage securities. At the time, Bear (which was later bought by J.P. Morgan) denied planning to engage in such transactions.
So far the latest dust-up has been all words, in part, bankers say, because they are wary of attracting more regulatory scrutiny at a time when lawmakers are planning major reforms in the largely unregulated derivatives markets, long lucrative for banks. While the banks' combined losses from the trade were in the tens of millions of dollars -- modest by recent standards -- they are the buzz of Wall Street as firms try to prevent a repeat of the episode.
The trade involved credit-default swaps and securities backed by subprime mortgages. The original securities had been sold by Lehman Brothers and were backed by $335 million of subprime mortgages mostly on homes in California made at the housing bubble's peak in 2005, according to the prospectus.
Following a wave of refinancing and defaults, only $29 million of the loans were left outstanding by March 2009, half of which were delinquent or in default, according to a performance report by Moody's Investors Service.
Believing the securities would become worthless, traders at J.P. Morgan bought credit-default swaps over the past year from Amherst, according to people familiar with the matter. Credit-default swaps act like insurance, paying off the buyer if securities are hit by losses. Other banks including RBS Securities, which is the U.S. investment-banking arm of Royal Bank of Scotland, and BofA also bought swaps on the securities from different trading partners.
The banks had to pay up for the protection, similar to a person buying insurance on a beach house just before a hurricane. They paid as much as 80 to 90 cents for every dollar of insurance, the going rate last fall according to dealer quotes, expecting to receive a dollar back when the securities became worthless over the coming months.
Traders can buy credit-default swaps on securities they don't own. At one point, at least $130 million of bets had been made on the performance of around $27 million in securities, according to a person familiar with the matter.
In late April, traders at some banks were shocked to find out from monthly remittance reports that the bonds they had bet against had been paid off in full. Normally an investor can't pay off loans like that but if the amount of outstanding loans falls to less than 10% of the original pool, the servicer -- or company that collects mortgage payments from homeowners and forwards them to investors who own the securities -- can buy them and make bondholders whole.
That's what happened in this case. In April, a servicer called Aurora Loan Services at the behest of Amherst purchased the remaining loans and paid off the bonds.
Although Amherst won't provide specifics and won't comment on its arrangement with Aurora, it doesn't deny that it took this approach. (Aurora says it is a subsidiary of Lehman Brothers Bank, but not part of the Lehman Brothers Holdings bankruptcy filing.)
A spokeswoman for Aurora says these servicer provisions are customary and when rights are exercised it ensures that appropriate requirements are met.
When the bonds got paid off, the swaps became worthless, meaning the banks effectively forfeited what they had paid for the insurance. J.P. Morgan lost millions, while RBS and BofA suffered minimal losses, said people familiar with the matter.
On April 28 representatives of banks including J.P. Morgan, Goldman Sachs Group Inc. and UBS AG's UBS Securities held a conference call to discuss the trade but didn't come to any conclusion, according to people familiar with the matter.
Amherst is the antithesis of the big Wall Street banks. With its Austin headquarters and around 100 employees, the 15-year-old firm has long been a player in the mortgage market, but is now one of the upstarts trying to take business from banks weakened by the credit crisis. The firms has hired bankers, mortgage traders and research analysts who had left banks such as Bear Stearns and UBS, while raising new capital to expand its trading activities.
Since the mortgage securities were valued at just $3 million or so in the market, well below the $27 million they were redeemed for, traders believe Amherst entered into an uneconomic transaction to profit from its swap positions.
Firms that suffered losses as well as some that didn't have brought the trade to the attention of two financial industry groups, the Securities Industry and Financial Markets Association, and the American Securitization Forum, which are considering their concerns, say people familiar with the trade groups' thinking.
Critics of these markets say such conflicts aren't a surprise. In secretive, over-the-counter markets "there are hidden risks and fault lines that don't show up until times of stress or when people are losing money," says Martin Weiss of Weiss Research, an investment consultancy in Jupiter, Fla., not involved in the trade.
Many credit-default swap contracts that were written on subprime mortgage securities over the past three years remain outstanding, and holders could lose out if more bonds are made whole. Deutsche Bank has sent a list, reviewed by The Wall Street Journal, to its clients of more than two dozen other mortgage pools that could see similar moves.
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com, Serena Ng at serena.ng@wsj.com and Liz Rappaport at liz.rappaport@wsj.com
Wednesday, June 10, 2009
Playing Mortgage Market Proves Tricky
By RUTH SIMON
As mortgage delinquencies have climbed, hundreds of investors have sought to profit by buying troubled loans from banks and other institutions, restructuring the mortgages to keep borrowers in their homes and quickly moving loans that can't be saved to foreclosure.
But as hedge-fund manager Ralph DellaCamera has learned, it has been a difficult strategy to pull off. Banks have been reluctant to sell loans at the price investors will pay for them. Meanwhile, the time it takes for investors to get their cash back has lengthened.
Still, interest remains high. "You may not like the price, but there is plenty of buying power out there," says William David Tobin, a principal with loan-sale adviser Mission Capital Advisors.
Banks' unwillingness to sell loans at steep discounts has also been an obstacle for the government's Public Private Investment Program, which was designed to help rid banks of troubled loans and securities.
Ernst Henry got refinancing for his Charlotte, N.C., house, seen Tuesday.
Banks generally would rather hold on to assets they believe have more inherent value, rather than sell them at a low point in the market.
Mr. DellaCamera bought his first distressed residential mortgages in December 2006, paying about 60 cents per dollar of unpaid principal. The following May, he set up a mortgage-servicing company to gain more control over negotiations with financially troubled homeowners.
DellaCamera Capital Management has so far invested about $150 million in residential mortgages and mortgage servicing, operating principally through a company called National Asset Direct and its affiliates. Mr. DellaCamera hasn't bought any mortgages since last summer, though he continues to look for more. Instead, he has been focusing on the mortgage servicing unit, which now handles about 1,100 loans for Mr. DellaCamera's firm and a handful of other investors who have bought mortgages at a discount.
"Initially, we thought there would be a plethora of opportunities" to buy loans, says Mr. DellaCamera, 55 years old, who headed trading at hedge fund Elliott Associates for more than a decade. "But we pulled back from buying these loans because the pricing isn't there and we were having trouble hedging." He calls servicing troubled loans a "tremendous opportunity."
Because most mortgage-loan sales are private, statistics are difficult to come by. Prices currently vary from 20 cents per dollar of unpaid principal for some of the riskiest subprime mortgages to nearly 90 cents on the dollar for current loans to borrowers in strong housing markets, says Kingsley Greenland, chief executive of DebtX, an online marketplace for loans.
Those types of prices would produce losses far greater than most have reserved for, says Keefe, Bruyette & Woods analyst Frederick Cannon. "Banks are essentially holding loans in the system at a value of 97.5 cents on the dollar," he says.
Investors can be more flexible in working with financially distressed homeowners, in part because they buy loans at a discount. Marix Servicing, which services loans for Marathon Asset Management and other hedge funds, will sometimes reduce the loan balance by an increasing amount each year for two or three years, provided the borrower stays current. Arc Westwood Home Saver Management, which bought a small pool of distressed mortgages last September to test its strategy, "can offer principal reductions in some cases of $100,000 or more," says executive vice president Michael Mattera.
National Asset Direct's iServe Servicing recently offered $50 American Express gift cards to 50 hard-to-reach borrowers, provided they agreed to a meeting. Four wound up with loan modifications; two sold their homes for less than the amount owed, with the company's approval.
Jimmy Cagle, a lumber salesman, was several months behind on the $313,000 mortgage on his Prosper, Texas, home, when his loan was purchased by an affiliate of National Asset Direct for an undisclosed discount. Ultimately, iServe cut Mr. Cagle's interest rate to 7.5% from 8.65%. It will likely reduce his loan balance to about $200,000 and refinance him into a new mortgage, provided he makes his loan payments for 12 months.
Staying current is still a challenge, "but we are getting it done," says Mr. Cagle, who has cut out luxuries such as trips to the local Cineplex.
Some mortgage investors have made principal reduction a part of their strategy, in part because it gives borrowers who owe more than their houses are worth an incentive to keep making payments. It is also easier to ultimately refinance or sell the mortgage if the borrower has equity.
But it can be difficult for investors to cash out. In the past, "reperforming" loans were packaged into securities and sold to investors, but such opportunities have become rare in the wake of the credit crisis. Refinancings have become more challenging as lenders have tightened standards.
Foreclosure moratoriums and other government actions have also increased the time it takes for investors to rid themselves of loans that can't be saved, lowering returns.
IServe hopes borrowers such as Mr. Cagle will ultimately refinance into Federal Housing Administration mortgages. The FHA doesn't generally require a minimum credit score, but borrowers must be current on their last 12 mortgage payments for a traditional refinancing. Many FHA lenders have set their own, tighter standards.
National Asset Direct has so far been able to arrange for less than a dozen refinances, mostly for people who were current on their payments, even though their loan was sold in a package of distressed mortgages. Among them: Ernst Henry, a respiratory therapist in Charlotte, N.C. Mr. Henry hadn't missed a single payment on his $149,000 interest-only mortgage, though falling prices meant he owed more than the house was worth.
When he opened a letter from iServe offering to reduce his mortgage balance, "my first reaction was to shred it," Mr. Henry recalls. Instead, he wound up with a $53,000 principal reduction that brought his mortgage in line with his home's value and made refinancing possible. Mr. Henry's monthly payments fell by about $380, though he now pays interest and principal.
National Asset Direct this month bought United Residential Lending, a mortgage banker, in part to speed such refinances. "We're holding on to a fair amount of loans we want to exit out of," said Chief Operating Officer Louis Amaya.
Write to Ruth Simon at ruth.simon@wsj.com
As mortgage delinquencies have climbed, hundreds of investors have sought to profit by buying troubled loans from banks and other institutions, restructuring the mortgages to keep borrowers in their homes and quickly moving loans that can't be saved to foreclosure.
But as hedge-fund manager Ralph DellaCamera has learned, it has been a difficult strategy to pull off. Banks have been reluctant to sell loans at the price investors will pay for them. Meanwhile, the time it takes for investors to get their cash back has lengthened.
Still, interest remains high. "You may not like the price, but there is plenty of buying power out there," says William David Tobin, a principal with loan-sale adviser Mission Capital Advisors.
Banks' unwillingness to sell loans at steep discounts has also been an obstacle for the government's Public Private Investment Program, which was designed to help rid banks of troubled loans and securities.
Ernst Henry got refinancing for his Charlotte, N.C., house, seen Tuesday.
Banks generally would rather hold on to assets they believe have more inherent value, rather than sell them at a low point in the market.
Mr. DellaCamera bought his first distressed residential mortgages in December 2006, paying about 60 cents per dollar of unpaid principal. The following May, he set up a mortgage-servicing company to gain more control over negotiations with financially troubled homeowners.
DellaCamera Capital Management has so far invested about $150 million in residential mortgages and mortgage servicing, operating principally through a company called National Asset Direct and its affiliates. Mr. DellaCamera hasn't bought any mortgages since last summer, though he continues to look for more. Instead, he has been focusing on the mortgage servicing unit, which now handles about 1,100 loans for Mr. DellaCamera's firm and a handful of other investors who have bought mortgages at a discount.
"Initially, we thought there would be a plethora of opportunities" to buy loans, says Mr. DellaCamera, 55 years old, who headed trading at hedge fund Elliott Associates for more than a decade. "But we pulled back from buying these loans because the pricing isn't there and we were having trouble hedging." He calls servicing troubled loans a "tremendous opportunity."
Because most mortgage-loan sales are private, statistics are difficult to come by. Prices currently vary from 20 cents per dollar of unpaid principal for some of the riskiest subprime mortgages to nearly 90 cents on the dollar for current loans to borrowers in strong housing markets, says Kingsley Greenland, chief executive of DebtX, an online marketplace for loans.
Those types of prices would produce losses far greater than most have reserved for, says Keefe, Bruyette & Woods analyst Frederick Cannon. "Banks are essentially holding loans in the system at a value of 97.5 cents on the dollar," he says.
Investors can be more flexible in working with financially distressed homeowners, in part because they buy loans at a discount. Marix Servicing, which services loans for Marathon Asset Management and other hedge funds, will sometimes reduce the loan balance by an increasing amount each year for two or three years, provided the borrower stays current. Arc Westwood Home Saver Management, which bought a small pool of distressed mortgages last September to test its strategy, "can offer principal reductions in some cases of $100,000 or more," says executive vice president Michael Mattera.
National Asset Direct's iServe Servicing recently offered $50 American Express gift cards to 50 hard-to-reach borrowers, provided they agreed to a meeting. Four wound up with loan modifications; two sold their homes for less than the amount owed, with the company's approval.
Jimmy Cagle, a lumber salesman, was several months behind on the $313,000 mortgage on his Prosper, Texas, home, when his loan was purchased by an affiliate of National Asset Direct for an undisclosed discount. Ultimately, iServe cut Mr. Cagle's interest rate to 7.5% from 8.65%. It will likely reduce his loan balance to about $200,000 and refinance him into a new mortgage, provided he makes his loan payments for 12 months.
Staying current is still a challenge, "but we are getting it done," says Mr. Cagle, who has cut out luxuries such as trips to the local Cineplex.
Some mortgage investors have made principal reduction a part of their strategy, in part because it gives borrowers who owe more than their houses are worth an incentive to keep making payments. It is also easier to ultimately refinance or sell the mortgage if the borrower has equity.
But it can be difficult for investors to cash out. In the past, "reperforming" loans were packaged into securities and sold to investors, but such opportunities have become rare in the wake of the credit crisis. Refinancings have become more challenging as lenders have tightened standards.
Foreclosure moratoriums and other government actions have also increased the time it takes for investors to rid themselves of loans that can't be saved, lowering returns.
IServe hopes borrowers such as Mr. Cagle will ultimately refinance into Federal Housing Administration mortgages. The FHA doesn't generally require a minimum credit score, but borrowers must be current on their last 12 mortgage payments for a traditional refinancing. Many FHA lenders have set their own, tighter standards.
National Asset Direct has so far been able to arrange for less than a dozen refinances, mostly for people who were current on their payments, even though their loan was sold in a package of distressed mortgages. Among them: Ernst Henry, a respiratory therapist in Charlotte, N.C. Mr. Henry hadn't missed a single payment on his $149,000 interest-only mortgage, though falling prices meant he owed more than the house was worth.
When he opened a letter from iServe offering to reduce his mortgage balance, "my first reaction was to shred it," Mr. Henry recalls. Instead, he wound up with a $53,000 principal reduction that brought his mortgage in line with his home's value and made refinancing possible. Mr. Henry's monthly payments fell by about $380, though he now pays interest and principal.
National Asset Direct this month bought United Residential Lending, a mortgage banker, in part to speed such refinances. "We're holding on to a fair amount of loans we want to exit out of," said Chief Operating Officer Louis Amaya.
Write to Ruth Simon at ruth.simon@wsj.com
Tuesday, June 9, 2009
中国私募基金正经历成长期阵痛
中国初生的私募基金产业正在经历成长期的阵痛。
中国本土私募基金中，包括渤海产业投资基金管理公司(Bohai Industrial Investment Fund Management Co. Investment)和厚朴投资管理公司(Hopu Investment Management Co.)等一些公司由于熟悉本土情况并且在政界广有人脉而被认为独具优势。然而，当前的金融危机正在暴露出这些公司的一些软肋。业界观察人士称，金融危机将使一些弱势公司被淘汰，其他公司将被迫作出改变。
软肋之一：作投资决策有时需过多考虑政治因素，而非投资回报。
璞玉投资管理公司(Jade Invest)的主管合伙人孔翔飞(Ludvig Nilsson)称，接近权力中心的价值在于，你可以对决策层施加影响；但有时候决策层也会对你施以影响。
渤海产业投资基金管理公司就是一家由政府牵头成立的基金，中国银行股份有限公司(Bank Of China Ltd.)持有其53%股权。该基金于2006年在高层官方支持下成立，在某些领域和交易方面该基金具有无与伦比的优势。然而，这同时也意味着，该基金不得不将大量资金花费在其总部所在地天津。渤海产业投资基金管理公司的首个投资项目便是2006年末对天津钢管集团股份有限公司((Tianjin Pipe (Group) Corp.))的投资，后者是一家天津政府掌控的石油套管生产公司。
而以厚朴为首的、由四家投资方组成的财团此前从美国银行(Bank of America Co., BAC)手中收购了中国建设银行(China Construction Bank) 73亿美元股票，当时有猜测认为厚朴迅速将股票倒手获利。
而实际上据知情人士透露，这只由顶级交易能手方风雷成立的基金不仅未出售上述股份，而且还有意将其握在手中至少两年；并且在上述股份中，厚朴所持有的份额占据较大比例。
对于厚朴成为建设银行重要股东一事，私募基金圈内人士说，必须有政府机构的首肯厚朴才会接盘建行股票，但这也使该基金难以迅速倒手抛出股票。尽管厚朴已经因其投资遭受非议，但该基金的平均回报率还是达到30%。
除了受到政治因素影响这一特点之外，这个刚刚起步的行业还存在另一个弱点：即缺少经验丰富的经理人。在中国和亚洲其他地区，很多基金经理中的新手能够在2007年和2008年初亚洲经济强劲增长的环境下融得上千万资金。对于那些争先恐后加入中国市场的投资者来说，中国庞大的市场规模和增长前景则尤为诱人。然而中国的私募基金大部分是由看到发展机遇的银行家和企业家发起的，而不是私募基金的专业人士。
有些时候，经验不够的还不单单是基金经理人，很多中国投资者对于将控制权交给基金经理人抱着警惕的态度。按照传统的私募基金模式，有限责任合伙人可以分享部分获利，但不能参与投资决定，但这种模式在中国并不总能行得通。
据业内人士称，渤海产业投资基金管理公司就摒弃了上述传统模式，在该基金中，投资者在投资决策方面具有更多的话语权。不过私募基金圈内人士也说，这给该公司带来了一些烦恼。例如，其创始人欧巍(Au Ngai)在执掌该公司两年之后离开了该公司，圈内人士认为他的离职说明该基金在结构和政治关系方面存在内部分歧。
China Venture研究部主管Young Zhang表示，中国投资者对于私募基金的运作并不熟悉，也不太适应，因此他们不是很愿意将资金交给普通合伙人去投资，不过一旦该行业成熟起来，情况将得到改观。
在金融危机洗礼之下，本土私募基金的能力将受考验。
中国监管层近年来已表示将发展本土私募基金业，尤其是人民币私募基金，以降低企业对银行融资的依赖性。
天津、杭州和上海均已采取了培育该行业以及鼓励成立私募基金的措施。据亚洲私人股本研究中心(Centre for Asia Private Equity Research)的资料显示，自2008年年初以来，人民币私募基金总共筹集了约165亿美元资金。
亚洲私人股本研究中心的董事总经理Kathleen Ng说，不少中国的私募基金公司正日渐成熟，并已逐渐了解予以投资者回报的必要性。
她还说，对于那些已经成立一段时间的本土私募基金管理公司而言，当前的金融危机将是对其能力的一种考验，因为这些公司投资组合中的某些企业正面临困境。
当然，在目前困难时期面临问题的并不只是本土私募基金公司。不过私募基金观察人士称，当前的环境将淘汰其中的弱势基金，长期而言对该行业有益。
China Venture研究部主管Young Zhang则表示，中国私募基金公司由于更加熟稔于本地市场并且拥有更好本地关系，因而有能力更好地施展其策略。
中国本土私募基金中，包括渤海产业投资基金管理公司(Bohai Industrial Investment Fund Management Co. Investment)和厚朴投资管理公司(Hopu Investment Management Co.)等一些公司由于熟悉本土情况并且在政界广有人脉而被认为独具优势。然而，当前的金融危机正在暴露出这些公司的一些软肋。业界观察人士称，金融危机将使一些弱势公司被淘汰，其他公司将被迫作出改变。
软肋之一：作投资决策有时需过多考虑政治因素，而非投资回报。
璞玉投资管理公司(Jade Invest)的主管合伙人孔翔飞(Ludvig Nilsson)称，接近权力中心的价值在于，你可以对决策层施加影响；但有时候决策层也会对你施以影响。
渤海产业投资基金管理公司就是一家由政府牵头成立的基金，中国银行股份有限公司(Bank Of China Ltd.)持有其53%股权。该基金于2006年在高层官方支持下成立，在某些领域和交易方面该基金具有无与伦比的优势。然而，这同时也意味着，该基金不得不将大量资金花费在其总部所在地天津。渤海产业投资基金管理公司的首个投资项目便是2006年末对天津钢管集团股份有限公司((Tianjin Pipe (Group) Corp.))的投资，后者是一家天津政府掌控的石油套管生产公司。
而以厚朴为首的、由四家投资方组成的财团此前从美国银行(Bank of America Co., BAC)手中收购了中国建设银行(China Construction Bank) 73亿美元股票，当时有猜测认为厚朴迅速将股票倒手获利。
而实际上据知情人士透露，这只由顶级交易能手方风雷成立的基金不仅未出售上述股份，而且还有意将其握在手中至少两年；并且在上述股份中，厚朴所持有的份额占据较大比例。
对于厚朴成为建设银行重要股东一事，私募基金圈内人士说，必须有政府机构的首肯厚朴才会接盘建行股票，但这也使该基金难以迅速倒手抛出股票。尽管厚朴已经因其投资遭受非议，但该基金的平均回报率还是达到30%。
除了受到政治因素影响这一特点之外，这个刚刚起步的行业还存在另一个弱点：即缺少经验丰富的经理人。在中国和亚洲其他地区，很多基金经理中的新手能够在2007年和2008年初亚洲经济强劲增长的环境下融得上千万资金。对于那些争先恐后加入中国市场的投资者来说，中国庞大的市场规模和增长前景则尤为诱人。然而中国的私募基金大部分是由看到发展机遇的银行家和企业家发起的，而不是私募基金的专业人士。
有些时候，经验不够的还不单单是基金经理人，很多中国投资者对于将控制权交给基金经理人抱着警惕的态度。按照传统的私募基金模式，有限责任合伙人可以分享部分获利，但不能参与投资决定，但这种模式在中国并不总能行得通。
据业内人士称，渤海产业投资基金管理公司就摒弃了上述传统模式，在该基金中，投资者在投资决策方面具有更多的话语权。不过私募基金圈内人士也说，这给该公司带来了一些烦恼。例如，其创始人欧巍(Au Ngai)在执掌该公司两年之后离开了该公司，圈内人士认为他的离职说明该基金在结构和政治关系方面存在内部分歧。
China Venture研究部主管Young Zhang表示，中国投资者对于私募基金的运作并不熟悉，也不太适应，因此他们不是很愿意将资金交给普通合伙人去投资，不过一旦该行业成熟起来，情况将得到改观。
在金融危机洗礼之下，本土私募基金的能力将受考验。
中国监管层近年来已表示将发展本土私募基金业，尤其是人民币私募基金，以降低企业对银行融资的依赖性。
天津、杭州和上海均已采取了培育该行业以及鼓励成立私募基金的措施。据亚洲私人股本研究中心(Centre for Asia Private Equity Research)的资料显示，自2008年年初以来，人民币私募基金总共筹集了约165亿美元资金。
亚洲私人股本研究中心的董事总经理Kathleen Ng说，不少中国的私募基金公司正日渐成熟，并已逐渐了解予以投资者回报的必要性。
她还说，对于那些已经成立一段时间的本土私募基金管理公司而言，当前的金融危机将是对其能力的一种考验，因为这些公司投资组合中的某些企业正面临困境。
当然，在目前困难时期面临问题的并不只是本土私募基金公司。不过私募基金观察人士称，当前的环境将淘汰其中的弱势基金，长期而言对该行业有益。
China Venture研究部主管Young Zhang则表示，中国私募基金公司由于更加熟稔于本地市场并且拥有更好本地关系，因而有能力更好地施展其策略。
Central banks will face a Scylla and Charybdis flation challenge for years
--Inflation is not an issue now since most excess reserve are piling up on Fed's balance sheet.
--But once these excess reserve are lent out, inflation will take hold because Fed has loaded its balance sheet with hard to sell assets
--High commoidty price is another factor that can drive up inflation as well.
by Edward Harrison of the site Credit Writedowns.
Nearly a month ago, back on May 5th, I highlighted some testimony by Federal Reserve Chairman Ben Bernanke before congress in a post labelled, “Bernanke expects recovery later this year". In his testimony, Bernanke used the phrase ‘Scylla and Charybdis’ to describe the Federal Reserve’s policy challenge regarding deflationary and inflationary forces. I would like to highlight this characterization because I believe it goes to the core of the debate as to how the global economy and asset markets will fare over the next 5-10 years. In my view (and apparently in Bernanke’s), both inflationary forces and deflationary forces will be at work for some time to come. This will present policy makers with a problem as the reflation trade comes good, and the resulting policy responses will have serious implications on the medium term outlook for the economy and asset markets.
Deflationary forces
The problem is this: we have just witnessed one of the most serious asset bubbles in history. In fact, I would call the great housing bubble an ‘echo bubble’ that was merely a continuation of the bubble forces that created the technology bubble of the late 1990s. So, the world saw asset price inflation of the most severe kind for over a decade – from the mid 1990s when Alan Greenspan first voiced concern about ‘irrational exuberance"’ to 2007 when the housing bubble imploded. What results from the implosion of such a significant bubble is deflation.
Actually, more crisply put, what results is ‘the D-process,’ an outcome highlighted by Ray Dalio of Bridgewater Associates (see my post "A conversation with Bridgewater Associates’ Ray Dalio" for more detail). This process involves the three D’s of deleveraging, deflation and depression (outlined in my post “We are in depression").
Richard Koo goes further in his book “The Holy Grail of Macro Economics.” Here, he argues that the unwind of great bubbles suffers from what he labels a ‘balance sheet recession.’ In essence, companies go from maximizing profits, as they had done in normal times, to a post-bubble concern of reducing debt. Regardless of how much priming of the pump monetary authorities do, the psychology of debt reduction will limit the effectiveness of monetary policy as a policy tool.
In my view, the catalyst for this change of psychology is the ‘debt revulsion’ that ushers in the panic phase of an asset bubble collapse. (Charles Kindleberger highlights the various stages of a bubble and its implosion in his seminal book “Manias, Panics and Crashes”). In this particular bubble, debt revulsion began post-Lehman Brothers. What we have seen, therefore, is a reduction in leverage and debt as the most leveraged players have gone to the wall. But, more than that, the household sector has gotten religion about debt reduction as the savings rate has increased dramatically since Lehman. In fact, I would argue that companies learned their lesson about debt from the aftermath of the tech bubble. It is the household sector in the U.S. (and the U.K.) which is heavily indebted. Therefore, if the psychology of a balance sheet recession does take form, it will be the household sector leading the charge.
In sum, the psychology after a major bubble is very different than the psychology before its collapse. The post-bubble emphasis becomes debt reduction and savings, making monetary policy ineffective, not because financial institutions are unwilling lenders but because companies and individuals are unwilling borrowers. These are forces to be reckoned with for some to come.
Inflationary forces
Meanwhile, inflation is going to be a problem too. Why? Two principle reasons come to mind: commodity prices and money supply. Now, just yesterday in my most recent post “Kasriel: ‘greater risk for the global economy…is inflation’,” I highlighted Paul Kasriel’s view that there are several inflationary forces, both secular and cyclical which will impinge upon the economy. I want to bear down on just the two forces of commodity prices and money supply.
First, let’s look at money supply. The Federal Reserve and other central banks have been pumping a lot of money into the financial system in an attempt to add reserves to the system and to take on the intermediation role the wider banking system normally serves. Nevertheless, this money is not being lent out and excess reserves are piling up at the Federal Reserve. Last April, there were only $1.8 billion in excess reserves i.e. reserves against which loans were not being made. According to figures just released by the Fed on May 28th, this April that figure has soared to $824.4 billion, a surge of 447 times in one year. If you want to know what is wrong with the American economy, you should start here.
But, what happens when the economy returns to an environment in which those excess reserves start to be lent out? Inflation. And this is an inflation that will not be so easy to control because the Federal Reserve has embarked on a policy of ‘qualitative easing’ by buying up non-treasury assets, transforming its balance sheet from one dominated by treasury assets to one in which Treasury assets are in the minority. So, as the Fed has intervened and bloated its balance sheet, an increasing amount of the assets it has with which to withdraw the excess liquidity in the system is hard to sell.
So, you have a huge amount of excess reserves, hard to sell assets on the Fed’s balance sheet. A
--But once these excess reserve are lent out, inflation will take hold because Fed has loaded its balance sheet with hard to sell assets
--High commoidty price is another factor that can drive up inflation as well.
by Edward Harrison of the site Credit Writedowns.
Nearly a month ago, back on May 5th, I highlighted some testimony by Federal Reserve Chairman Ben Bernanke before congress in a post labelled, “Bernanke expects recovery later this year". In his testimony, Bernanke used the phrase ‘Scylla and Charybdis’ to describe the Federal Reserve’s policy challenge regarding deflationary and inflationary forces. I would like to highlight this characterization because I believe it goes to the core of the debate as to how the global economy and asset markets will fare over the next 5-10 years. In my view (and apparently in Bernanke’s), both inflationary forces and deflationary forces will be at work for some time to come. This will present policy makers with a problem as the reflation trade comes good, and the resulting policy responses will have serious implications on the medium term outlook for the economy and asset markets.
Deflationary forces
The problem is this: we have just witnessed one of the most serious asset bubbles in history. In fact, I would call the great housing bubble an ‘echo bubble’ that was merely a continuation of the bubble forces that created the technology bubble of the late 1990s. So, the world saw asset price inflation of the most severe kind for over a decade – from the mid 1990s when Alan Greenspan first voiced concern about ‘irrational exuberance"’ to 2007 when the housing bubble imploded. What results from the implosion of such a significant bubble is deflation.
Actually, more crisply put, what results is ‘the D-process,’ an outcome highlighted by Ray Dalio of Bridgewater Associates (see my post "A conversation with Bridgewater Associates’ Ray Dalio" for more detail). This process involves the three D’s of deleveraging, deflation and depression (outlined in my post “We are in depression").
Richard Koo goes further in his book “The Holy Grail of Macro Economics.” Here, he argues that the unwind of great bubbles suffers from what he labels a ‘balance sheet recession.’ In essence, companies go from maximizing profits, as they had done in normal times, to a post-bubble concern of reducing debt. Regardless of how much priming of the pump monetary authorities do, the psychology of debt reduction will limit the effectiveness of monetary policy as a policy tool.
In my view, the catalyst for this change of psychology is the ‘debt revulsion’ that ushers in the panic phase of an asset bubble collapse. (Charles Kindleberger highlights the various stages of a bubble and its implosion in his seminal book “Manias, Panics and Crashes”). In this particular bubble, debt revulsion began post-Lehman Brothers. What we have seen, therefore, is a reduction in leverage and debt as the most leveraged players have gone to the wall. But, more than that, the household sector has gotten religion about debt reduction as the savings rate has increased dramatically since Lehman. In fact, I would argue that companies learned their lesson about debt from the aftermath of the tech bubble. It is the household sector in the U.S. (and the U.K.) which is heavily indebted. Therefore, if the psychology of a balance sheet recession does take form, it will be the household sector leading the charge.
In sum, the psychology after a major bubble is very different than the psychology before its collapse. The post-bubble emphasis becomes debt reduction and savings, making monetary policy ineffective, not because financial institutions are unwilling lenders but because companies and individuals are unwilling borrowers. These are forces to be reckoned with for some to come.
Inflationary forces
Meanwhile, inflation is going to be a problem too. Why? Two principle reasons come to mind: commodity prices and money supply. Now, just yesterday in my most recent post “Kasriel: ‘greater risk for the global economy…is inflation’,” I highlighted Paul Kasriel’s view that there are several inflationary forces, both secular and cyclical which will impinge upon the economy. I want to bear down on just the two forces of commodity prices and money supply.
First, let’s look at money supply. The Federal Reserve and other central banks have been pumping a lot of money into the financial system in an attempt to add reserves to the system and to take on the intermediation role the wider banking system normally serves. Nevertheless, this money is not being lent out and excess reserves are piling up at the Federal Reserve. Last April, there were only $1.8 billion in excess reserves i.e. reserves against which loans were not being made. According to figures just released by the Fed on May 28th, this April that figure has soared to $824.4 billion, a surge of 447 times in one year. If you want to know what is wrong with the American economy, you should start here.
But, what happens when the economy returns to an environment in which those excess reserves start to be lent out? Inflation. And this is an inflation that will not be so easy to control because the Federal Reserve has embarked on a policy of ‘qualitative easing’ by buying up non-treasury assets, transforming its balance sheet from one dominated by treasury assets to one in which Treasury assets are in the minority. So, as the Fed has intervened and bloated its balance sheet, an increasing amount of the assets it has with which to withdraw the excess liquidity in the system is hard to sell.
So, you have a huge amount of excess reserves, hard to sell assets on the Fed’s balance sheet. A