Dark side of the lending boom

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.

《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.

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.

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

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

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.

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

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

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

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

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

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.

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.

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.

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

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

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.”

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.

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.

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.

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.