A special report on managing information

Data, data everywhere

Information has gone from scarce to superabundant. That brings huge new benefits, says Kenneth Cukier (interviewed here)—but also big headaches

Feb 25th 2010
From The Economist print edition



WHEN the Sloan Digital Sky Survey started work in 2000, its telescope in New Mexico collected more data in its first few weeks than had been amassed in the entire history of astronomy. Now, a decade later, its archive contains a whopping 140 terabytes of information. A successor, the Large Synoptic Survey Telescope, due to come on stream in Chile in 2016, will acquire that quantity of data every five days.



Such astronomical amounts of information can be found closer to Earth too. Wal-Mart, a retail giant, handles more than 1m customer transactions every hour, feeding databases estimated at more than 2.5 petabytes—the equivalent of 167 times the books in America’s Library of Congress (see article for an explanation of how data are quantified). Facebook, a social-networking website, is home to 40 billion photos. And decoding the human genome involves analysing 3 billion base pairs—which took ten years the first time it was done, in 2003, but can now be achieved in one week.



All these examples tell the same story: that the world contains an unimaginably vast amount of digital information which is getting ever vaster ever more rapidly. This makes it possible to do many things that previously could not be done: spot business trends, prevent diseases, combat crime and so on. Managed well, the data can be used to unlock new sources of economic value, provide fresh insights into science and hold governments to account.



But they are also creating a host of new problems. Despite the abundance of tools to capture, process and share all this information—sensors, computers, mobile phones and the like—it already exceeds the available storage space (see chart 1). Moreover, ensuring data security and protecting privacy is becoming harder as the information multiplies and is shared ever more widely around the world.



Alex Szalay, an astrophysicist at Johns Hopkins University, notes that the proliferation of data is making them increasingly inaccessible. “How to make sense of all these data? People should be worried about how we train the next generation, not just of scientists, but people in government and industry,” he says.



“We are at a different period because of so much information,” says James Cortada of IBM, who has written a couple of dozen books on the history of information in society. Joe Hellerstein, a computer scientist at the University of California in Berkeley, calls it “the industrial revolution of data”. The effect is being felt everywhere, from business to science, from government to the arts. Scientists and computer engineers have coined a new term for the phenomenon: “big data”.


Epistemologically speaking, information is made up of a collection of data and knowledge is made up of different strands of information. But this special report uses “data” and “information” interchangeably because, as it will argue, the two are increasingly difficult to tell apart. Given enough raw data, today’s algorithms and powerful computers can reveal new insights that would previously have remained hidden.



The business of information management—helping organisations to make sense of their proliferating data—is growing by leaps and bounds. In recent years Oracle, IBM, Microsoft and SAP between them have spent more than $15 billion on buying software firms specialising in data management and analytics. This industry is estimated to be worth more than $100 billion and growing at almost 10% a year, roughly twice as fast as the software business as a whole.



Chief information officers (CIOs) have become somewhat more prominent in the executive suite, and a new kind of professional has emerged, the data scientist, who combines the skills of software programmer, statistician and storyteller/artist to extract the nuggets of gold hidden under mountains of data. Hal Varian, Google’s chief economist, predicts that the job of statistician will become the “sexiest” around. Data, he explains, are widely available; what is scarce is the ability to extract wisdom from them.



More of everything

There are many reasons for the information explosion. The most obvious one is technology. As the capabilities of digital devices soar and prices plummet, sensors and gadgets are digitising lots of information that was previously unavailable. And many more people have access to far more powerful tools. For example, there are 4.6 billion mobile-phone subscriptions worldwide (though many people have more than one, so the world’s 6.8 billion people are not quite as well supplied as these figures suggest), and 1 billion-2 billion people use the internet.



Moreover, there are now many more people who interact with information. Between 1990 and 2005 more than 1 billion people worldwide entered the middle class. As they get richer they become more literate, which fuels information growth, notes Mr Cortada. The results are showing up in politics, economics and the law as well. “Revolutions in science have often been preceded by revolutions in measurement,” says Sinan Aral, a business professor at New York University. Just as the microscope transformed biology by exposing germs, and the electron microscope changed physics, all these data are turning the social sciences upside down, he explains. Researchers are now able to understand human behaviour at the population level rather than the individual level.



The amount of digital information increases tenfold every five years. Moore’s law, which the computer industry now takes for granted, says that the processing power and storage capacity of computer chips double or their prices halve roughly every 18 months. The software programs are getting better too. Edward Felten, a computer scientist at Princeton University, reckons that the improvements in the algorithms driving computer applications have played as important a part as Moore’s law for decades.



A vast amount of that information is shared. By 2013 the amount of traffic flowing over the internet annually will reach 667 exabytes, according to Cisco, a maker of communications gear. And the quantity of data continues to grow faster than the ability of the network to carry it all.



People have long groused that they were swamped by information. Back in 1917 the manager of a Connecticut manufacturing firm complained about the effects of the telephone: “Time is lost, confusion results and money is spent.” Yet what is happening now goes way beyond incremental growth. The quantitative change has begun to make a qualitative difference.



This shift from information scarcity to surfeit has broad effects. “What we are seeing is the ability to have economies form around the data—and that to me is the big change at a societal and even macroeconomic level,” says Craig Mundie, head of research and strategy at Microsoft. Data are becoming the new raw material of business: an economic input almost on a par with capital and labour. “Every day I wake up and ask, ‘how can I flow data better, manage data better, analyse data better?” says Rollin Ford, the CIO of Wal-Mart.



Sophisticated quantitative analysis is being applied to many aspects of life, not just missile trajectories or financial hedging strategies, as in the past. For example, Farecast, a part of Microsoft’s search engine Bing, can advise customers whether to buy an airline ticket now or wait for the price to come down by examining 225 billion flight and price records. The same idea is being extended to hotel rooms, cars and similar items. Personal-finance websites and banks are aggregating their customer data to show up macroeconomic trends, which may develop into ancillary businesses in their own right. Number-crunchers have even uncovered match-fixing in Japanese sumo wrestling.



Dross into gold

“Data exhaust”—the trail of clicks that internet users leave behind from which value can be extracted—is becoming a mainstay of the internet economy. One example is Google’s search engine, which is partly guided by the number of clicks on an item to help determine its relevance to a search query. If the eighth listing for a search term is the one most people go to, the algorithm puts it higher up.



As the world is becoming increasingly digital, aggregating and analysing data is likely to bring huge benefits in other fields as well. For example, Mr Mundie of Microsoft and Eric Schmidt, the boss of Google, sit on a presidential task force to reform American health care. “Early on in this process Eric and I both said: ‘Look, if you really want to transform health care, you basically build a sort of health-care economy around the data that relate to people’,” Mr Mundie explains. “You would not just think of data as the ‘exhaust’ of providing health services, but rather they become a central asset in trying to figure out how you would improve every aspect of health care. It’s a bit of an inversion.”



To be sure, digital records should make life easier for doctors, bring down costs for providers and patients and improve the quality of care. But in aggregate the data can also be mined to spot unwanted drug interactions, identify the most effective treatments and predict the onset of disease before symptoms emerge. Computers already attempt to do these things, but need to be explicitly programmed for them. In a world of big data the correlations surface almost by themselves.



Sometimes those data reveal more than was intended. For example, the city of Oakland, California, releases information on where and when arrests were made, which is put out on a private website, Oakland Crimespotting. At one point a few clicks revealed that police swept the whole of a busy street for prostitution every evening except on Wednesdays, a tactic they probably meant to keep to themselves.



But big data can have far more serious consequences than that. During the recent financial crisis it became clear that banks and rating agencies had been relying on models which, although they required a vast amount of information to be fed in, failed to reflect financial risk in the real world. This was the first crisis to be sparked by big data—and there will be more.



The way that information is managed touches all areas of life. At the turn of the 20th century new flows of information through channels such as the telegraph and telephone supported mass production. Today the availability of abundant data enables companies to cater to small niche markets anywhere in the world. Economic production used to be based in the factory, where managers pored over every machine and process to make it more efficient. Now statisticians mine the information output of the business for new ideas.



“The data-centred economy is just nascent,” admits Mr Mundie of Microsoft. “You can see the outlines of it, but the technical, infrastructural and even business-model implications are not well understood right now.” This special report will point to where it is beginning to surface.

MGM Mirage Gets Reprieve On Bank Debt

Lenders of $4.37 Billion Agree to Defer Repayment Until 2014 for Troubled Developer of Las Vegas Casino and Resort By ALEXANDRA BERZON Lenders to MGM Mirage have given the Las Vegas-based casino company two more years to pay back a portion of a loan that was to come due in October 2011, the company disclosed Friday. The deadline for the $5.55 billion senior bank credit facility had been a significant hurdle facing the debt-laden company, amid continued weakness in the Las Vegas casino industry. MGM Mirage Chief Financial Officer Dan D'Arrigo called the agreement a "milestone" in efforts to improve the company's balance sheet, which has around $12.5 billion in debt, and further indication that a bank group led by Bank of America Corp., Royal Bank of Scotland, and JP Morgan are willing to be flexible with the casino company. MGM Mirage, already shouldering debt from previous acquisitions, was a profligate borrower during the days of easy credit. To finance an expansion in Asia and upgrade Las Vegas casinos, the company racked up debt that at one time totaled $14 billion. When Las Vegas fell victim to a massive downturn in spending last year, MGM Mirage teetered on the edge of bankruptcy, straining to make $100 million monthly payments on its $8.5 billion City Center project. Lenders amended the terms of the loan eight times to help the company regain its footing. But the question of the credit facility's maturation in 2011 had still hung over the company. "This shows the environment for both banks and our company is a lot more stable," Mr. D'Arrigo said. "We're not out of the woods but the banks clearly have put a lot of faith in our company and know that over time this business will recover." Around 80% of lenders agreed to new terms, which extends the loan to February 21, 2014. The company will have to increase its interest payments to 7% from 6% to those lenders and will also have to pay back around $820 million by June, Mr. D'Arrigo said. The new terms allows the company to issue bonds secured by a casino asset to make that payment. The company will still have to come up with around $1.2 billion by Oct.3, 2011, to pay the lenders who did not agree to the new credit terms. Mr. D'Arrigo said the company has been working for around six weeks on the new agreement. It had previously told investors that an extension was in the works. "This is one step to get investors more comfortable," said Chris Snow, an analyst for CreditSights. "It's one more step to shore up the financial structure. This company still has a lot of work to do. They're going to have to keep focusing on their balance sheet." Another step the company expects to make to pay down debt is an initial public offering in Hong Kong based on its joint venture casino partnership in Macau, as other companies have done. Analysts estimate that IPO could raise between $250 million and $500 million for the company. MGM Mirage also could re-capitalize its $8.5 billion CityCenter casino, hotel, condo and retail joint venture project, which has relatively little debt. But that could prove challenging if condo sales there are slow during a difficult real estate market, analysts say. Las Vegas—where the company reaps around 75% of its revenue—is still on the decline as casino companies continue to slash room rates and visitors continue to spend less. MGM Mirage recently reported that its revenue fell 11% in the fourth quarter of last year. Average hotel rates in Las Vegas declined 5.8% in December, according to the most recent data available from the Las Vegas Convention and Visitors Authority, as operators offered deals in an attempt to entice visitors. Rates fell 22% for the year. MGM Mirage executives, unlike Las Vegas competitors who say the outlook there remains bleak, believe the city will begin to see recovery by the second half of this year, based on their advanced bookings. "Nobody knows more about this city than we do," Mr. D'Arrigo said. "Clearly we see some positive signs in our business."

Is the Dismal Science Really a Science?

.By RUSS ROBERTS For an economist, these are the best of times and the worst of times. We live in the best of times because everyone wants to understand what happened to the economy and what's going to happen next. Is the mess we're in a market failure or a government failure? Is the stimulus plan working? Would tax cuts for small business spur employment? When will the job market improve? Is inflation coming? Do deficits matter? So many questions and so little in the way of answers. And so it is the worst of times for economists. There is no consensus on the cause of the crisis or the best way forward. There were Nobel Laureates who thought the original stimulus package should have been twice as big. And there are those who blame it for keeping unemployment high. Some economists warn of hyperinflation while others tell us not to worry. It makes you wonder why people call it the Nobel Prize in Economic Science. After all, most sciences make progress. Nobody in medicine wants to bring back lead goblets. Sir Isaac Newton understood a lot about gravity. But Albert Einstein taught us more. But in economics, theories that were once discredited surge back into favor. John Maynard Keynes and the view that government spending can create prosperity seem immortal. I thought stagflation had put a stake in the heart of this idea back in the 1970s. Suddenly, he's a genius once again. F.A. Hayek, Keynes's more laissez-faire sparring partner, is drawing interest. There are various monetarists to choose from, too. Which paradigm is the "right" way to think about the boom and the bust? Or are they all wrong? I once thought econometrics—the application of statistics to economic questions—would settle these disputes and the truth would out. Econometrics is often used to measure the independent impact of one variable holding the rest of the relevant factors constant. But I've come to believe there are too many factors we don't have data on, too many connections between the variables we don't understand and can't model or identify. I've started asking economists if they can name a study that applied sophisticated econometrics to a controversial policy issue where the study was so well done that one side's proponents had to admit they were wrong. I don't know of any. One economist told me that in general my point was well taken, but that his own work (of course!) had been decisive in settling a particular dispute. Perhaps what we're really doing is confirming our biases. Ed Leamer, a professor of economics at UCLA, calls it "faith-based" econometrics. When the debate is over $2 trillion in additional government spending vs. zero, we've stopped being scientists and become philosophers. Do we want to be more like France with a bigger role for government, or less like France? Facts and evidence still matter. And economists have learned some things that have stood the test of time and that we almost all agree on—the general connection between the money supply and inflation, for example. But the arsenal of the modern econometrician is vastly overrated as a diviner of truth. Nearly all economists accept the fundamental principles of microeconomics—that incentives matter, that trade creates prosperity—even if we disagree on the implications for public policy. But the business cycle and the ability to steer the economy out of recession may be beyond us. The defenders of modern macroeconomics argue that if we just study the economy long enough, we'll soon be able to model it accurately and design better policy. Soon. That reminds me of the permanent sign in the bar: Free Beer Tomorrow. We should face the evidence that we are no better today at predicting tomorrow than we were yesterday. Eighty years after the Great Depression we still argue about what caused it and why it ended. If economics is a science, it is more like biology than physics. Biologists try to understand the relationships in a complex system. That's hard enough. But they can't tell you what will happen with any precision to the population of a particular species of frog if rainfall goes up this year in a particular rain forest. They might not even be able to count the number of frogs right now with any exactness. We have the same problems in economics. The economy is a complex system, our data are imperfect and our models inevitably fail to account for all the interactions. The bottom line is that we should expect less of economists. Economics is a powerful tool, a lens for organizing one's thinking about the complexity of the world around us. That should be enough. We should be honest about what we know, what we don't know and what we may never know. Admitting that publicly is the first step toward respectability. Mr. Roberts is a research fellow at Stanford University's Hoover Institution, professor of economics at George Mason University and a distinguished scholar in the Mercatus Center.

Economy in U.S. Expanded at 5.9 Percent Pace in Fourth Quarter

By Timothy R. Homan Feb. 26 (Bloomberg) -- The economy in the U.S. expanded at a 5.9 percent annual rate in the fourth quarter, more than the government reported last month, reflecting stronger business investment and a greater contribution from inventories. The rise in gross domestic product, which exceeded the median forecast of economists surveyed by Bloomberg News, marked the best performance in more than six years, the Commerce Department said today in Washington. Inventories added 3.88 percentage points to GDP, more than previously reported, and investment in software and equipment grew at the fastest pace in almost a decade. Manufacturers such as Deere & Co. may continue to lead the recovery as increasing sales prompt companies to boost purchases and add to stockpiles. At the same time, consumer spending, which accounts for 70 percent of the economy, is likely to be restrained by an unemployment rate that’s forecast to average 9.8 percent this year. “Business equipment investment will continue to make a significant contribution to growth in 2010,” Brian Bethune, chief U.S. financial economist at IHS Global Insight in Lexington, Massachusetts, said before the report. “Consumer spending is not expected to energize the recovery in 2010, but rather plod along at relatively subdued rates.” The economy was forecast to grow at a 5.7 percent annual pace, the same rate the government initially reported in January, according to the median estimate of 76 economists in a Bloomberg News survey. Estimates ranged from gains of 4.2 percent to 6.3 percent. 2.4% Decline For all of 2009, the economy shrank 2.4 percent, the worst single-year performance since 1946. The GDP report is the second for the fourth quarter and will be revised in March as more information, such as corporate profits, becomes available to the government. Consumer spending rose at a 1.7 percent pace, compared with the 2 percent rate forecast by economists and a 2.8 percent gain in the prior quarter. Spending added 1.23 percentage points to GDP. Third-quarter purchases received a boost from the government’s auto-incentive program that offered buyers discounts to trade in older cars and trucks for new, more fuel-efficient vehicles. The plan expired in August. Household purchases dropped 0.6 percent last year, the biggest decrease since 1974. Inventories Increases in production last quarter stemmed the slide in inventories from earlier in the year. Stockpiles dropped at a $16.9 billion annual pace following a $139.2 billion decline the previous three months. Inventories declined at a record $160.2 billion pace in the second quarter. Today’s report showed purchases of equipment and software increased at an 18.2 percent pace in the fourth quarter, the most since 2000. The gain helped offset a 13.9 percent drop in commercial construction, leaving total business investment up 6.2 percent during the final three months of 2009. A report yesterday showed companies ordered more capital goods in January, driven primarily by bookings for commercial aircraft. Declines in other, less volatile industries indicate business investment may be slowing, according to yesterday’s Commerce Department figures. The job market is one part of the economy where a recovery is slow to take hold. Payrolls fell by 20,000 last month after a 150,000 drop in December. The U.S. has lost 8.4 million since the start of the recession in December 2007, the most of any slowdown in the post-World War II era. Unemployment The jobless rate fell to 9.7 percent in January, the Labor Department said on Feb. 5. Unemployment is projected to end the year at 9.5 percent, according to a Bloomberg survey. In other areas of the economy, today’s report showed a smaller trade deficit, which contributed 0.3 percentage point to fourth-quarter growth. Government spending fell at a 1.2 percent pace after a 2.6 percent increase the previous quarter. Residential construction climbed at a 5 percent rate last quarter after expanding at a 18.9 percent pace in the previous three months. Deere, the world’s largest maker of farm machinery, posted first-quarter profit this month that topped analysts’ estimates and raised its 2010 forecast. Chief Executive Officer Samuel Allen said Feb. 17 that full-year equipment revenue will increase as much as 8 percent. “Positive developments based on the world’s prospects for population and economic growth hold great potential and should help our company,” he said in a statement. Inflation stayed within the Fed’s long-term forecast range, today’s report showed. The central bank’s preferred price gauge, which is tied to consumer spending and strips out food and energy costs, rose at a 1.6 percent annual pace following a 1.2 percent increase in the prior quarter. The GDP price gauge climbed at a 0.4 percent pace, less than the 0.6 percent median forecast of economists surveyed. To contact the reporter on this story: Timothy R. Homan in Washington at thoman1@bloomberg.net

下周解禁潮来势汹汹 中国平安领衔 A股将扛不住？

中金在线/财经编辑部　

　　如何看待平安职工股解禁？

　　如果一个人投资2万元，苦干18年取得商业上的成功，如今收获200万元回报，这样的故事在中国算得上是“暴富”神话吗？这个投资年回报率相当于29%，高出GDP增长2.5倍，算是不错，如果手段当正合法，那“赚”得其所，无可厚非。这就是中国平安职工股从入资到解禁的回报。

　　几天前中国平安发布公告，3月1日起由三家职工持股公司持有的8.6亿股将进入流通时代，这些股票可在五年内分批减持，按目前市值计算，约为387亿元。股票被1.9万名中国平安职工和高管持有，通过本报测算，持股成本约7.8亿元，最长的持有时间18年，增值100倍。

　　但此消息引起一片哗然，机构纷纷抛售，2月23日中国平安股价大跌8.88%，创下其上市以来第二大成交量，也是当天A股市场成交金额最大的一只股票。平安股价大跌还拖累A股整体走弱，当日上证指数下跌0.69%。

　　人们对中国平安的争议，不只是其职工股解禁消息带来的股市下跌，更多的是对1.9万人身价过百万、公司高管马明哲坐拥7亿元财富的不满，进而引发对中国平安员工分享公司成长红利的合理性质疑，而且这种质疑，从马明哲天价年薪开始，就一直困扰着中国平安。

　　但盲目的仇富心态，并不能让社会变得更美好。我们反对用不公平和不道德的手段敛取不义之财，但我们更提倡通过勤劳、坚韧和智慧来创造和获取财富，只有当整个社会能够对“阳光下获取的财富”报以欣赏和鼓励，同时通过健全法治来保证创造财富的“过程平等”时，才有可能实现国民共富、社会共赢。

　　中国经济和资本市场高速发展的过程，也是狂热的“造富”过程。据胡润研究院统计，在我国目前100亿级富翁有200人，10亿级富翁2000人，亿万富翁约5万人，而千万富翁约80万人。美林全球财富管理公司和凯捷咨询最近公布的《2009年世界财富报告》显示，中国内地富豪人数首次超过英国，上升至全球第四位，甚至有望在2013年超越北美。

　　这个规模庞大的富人群体，主要产生于房地产、制造和金融等行业，我们相信其中不乏合法创富者。但历年“胡润富豪榜”被称之为“杀手榜”的事实也告诉我们，很多富人的存折都经不起阳光的暴晒。更有不少“无法统计”的富人，或利用权钱交易巧取豪夺，或腾挪国有资产秘密分赃，这种“无本万利”的财富来源，才是造成当前社会仇富心态的根源。

　　另一种仇富，来自于体制内和体制外的收入差异。一些国有企业和部门，以保障员工福利之名行私分全民财富之实，将利用资源垄断获取的暴利，慷慨地分配给内部员工。其中引起巨大非议的例子，就是2008年底的“中石油购房门”事件，当时中石油集团下属的北京华油服务总公司，以单价每平方米不到万元的价格，团购了北京太阳星城的8栋住宅楼，而当时该楼盘均价23000元。

　　反观中国平安的造富过程，却是经过了22年的持续发展和18年的波折等待。1988年成立时公司只有13人，几乎白手起家，但22年过去了，公司总资产由当时的5312万元达到2009年的8732亿元，净利润也由1988年的482万元达到2009年的105亿元。1992年开始，公司开创性地实施了员工持股计划，首先以平安职工合股基金方式出资2236万元认购了当时10%的股权，其后又几经增持达到目前的持股规模。相对创造出资产增长1.6万倍、净利润增长2178倍的业绩而言，相对打造出了中国最大最成功的金融企业而言，中国平安职工股权价值的增值，比起那些几十亿、上百亿身家的股市新贵们，应该是合理、公平的。

　　中国平安减持消息一出，就有媒体采访“肠子都悔青了”的平安老员工，他们或者当初不愿参与内部职工股的申购，或者早早地把股权转卖、退出。只有一直坚持下来，伴随平安一起创造巨大商业成功的那部分人，最终收获了可观的投资回报。可以说，中国平安的员工创富过程值得称赞。

　　市场没有必要担心职工股的解禁，这反而能把一个公司的内在价值，更充分地暴露在投资者面前。企业内部人员，特别是高层管理者比普通投资人更了解公司的情况，他们对自家股票的买卖，可以成为我们判断公司价值的风向标。如果中国平安具备长期投资价值，它的员工和高管对公司股票的态度，应该是增持而不是减持；而如果限售股流通后，他们都迫不及待地抛售，投资者到是要小心了。

　　不过，想经得起社会的质疑，中国平安应进一步将职工持股透明化。究竟8.6亿的股票是不是全都由内部职工持有？职工股的分配机制是否能起到激励员工的效果？是否存在“赎买权力”的特殊股票？这些疑问只有充分公开才能得以消释，而职工持股公司代持的方式，让原本阳光的财富蒙上了一层不必要的阴影。从这个意义上讲，中国平安倒应该取消代持机制，由职工直接持有公司股票，把更多的持股信息披露出来，让市场检验。

　　财富只有更阳光和正当，才能促进公平；市场只有更透明和自由，才能变得健康。不是吗？(投资者报)

Hedge Funds Try 'Career Trade' Against Euro

By SUSAN PULLIAM, KATE KELLYand CARRICK MOLLENKAMP

Some heavyweight hedge funds have launched large bearish bets against the euro in moves that are reminiscent of the trading action at the height of the U.S. financial crisis.



The big bets are emerging amid gatherings such as an exclusive "idea dinner" earlier this month that included hedge-fund titans SAC Capital Advisors LP and Soros Fund Management LLC. During the dinner, hosted by a boutique investment bank at a private townhouse in Manhattan, a small group of all-star hedge-fund managers argued that the euro is likely to fall to "parity"—or equal on an exchange basis—with the dollar, people close to the situation say.



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European Pressphoto Agency



George Soros, head of the $27-billion asset fund manager, warned publicly last weekend that if the European Union doesn't fix its finances, "the euro may fall apart."

.The currency wagers signal that big financial players spot a rare trading opening driven by broader market gyrations. The euro, which traded at $1.51 in December, now trades around $1.35. With traders using leverage—often borrowing 20 times the size of their bet, accentuating gains and losses—a euro move to $1 could represent a career trade. If investors put up $5 million to make a $100 million trade, a 5% price move in the right direction doubles their initial investment.



"This is an opportunity...to make a lot of money," says Hans Hufschmid, a former senior Salomon Brothers executive who now runs GlobeOp Financial Services SA, a hedge-fund administrator in London and New York.



It is impossible to calculate the precise effect of the elite traders' bearish bets, but they have added to the selling pressure on the currency—and thus to the pressure on the European Union to stem the Greek debt crisis.



There is nothing improper about hedge funds jumping on the same trade unless it is deemed by regulators to be collusion. Regulators haven't suggested that any trading has been improper.



Through small gatherings, hedge funds can discuss similar trades that can feed on each other, in moves similar to those criticized by some investors and bankers in 2008. Then, big hedge-fund managers, such as Greenlight Capital Inc. President David Einhorn, who also was at this month's euro-dominated dinner, determined that the fortunes of Lehman Brothers Holdings and other firms were dim and bet heavily against their securities, accelerating their decline.



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SIPA



David Einhorn, president of Greenlight Capital

.An SAC manager, Aaron Cowen, who pitched the group on the bearish bet, said he viewed all possible outcomes relating to the Greek debt crisis as negative for the euro, people familiar with the matter say. SAC's trading position on the euro is unclear.



George Soros, head of the $27-billion asset fund manager, warned publicly last weekend that if the European Union doesn't fix its finances, "the euro may fall apart." Through a spokesman for Soros Fund Management, he declined to comment for this article.



A Greek finance ministry official declined comment. A European Commission spokeswoman said the Commission doesn't comment on market rumors, adding that the EU's executive arm is working toward developing rules to tighten regulation and risk.



Few traders expect the value of the euro to totally collapse, the way the British pound did in 1992 amid a large bearish bet by Mr. Soros. In that famous trade—which traders say led to a $1 billion profit—selling led by Mr. Soros pushed the pound's value so low that Britain was forced to withdraw its currency from the European Exchange Rate Mechanism, causing the pound to drop even more sharply. The euro is an extremely deep market, with at least $1.2 trillion in daily trading volume, dwarfing the British pound's daily trading volume in 1992.



Again, derivatives, known as credit default swaps, are playing a part in the current trading. Some of the largest hedge funds, including Paulson & Co., which manages $32 billion, have bought such swaps, traders say, which act as insurance against a default by Greece on its sovereign debt. Traders view higher swaps prices as warning signs of potential default.



More on Greece

Greece Delays Bond Sale Amid New Turmoil

Fed Probes Swaps Deals by Goldman, Others

U.K. Pound Tops Euro as Biggest Loser

Complete Coverage: Greece's Debt Crisis

.Since December, the prices of such swaps have more than doubled, reflecting investors concerns about a default by Greece. Paulson had built a large bearish position on Europe, people familiar with the matter say, including swaps that will pay out if Greece defaults on its debt within five years.



Paulson since has closed out that position and has taken the other side of the bet, leaving the firm with a bullish stance now, a person familiar with the matter says.



In a statement, Paulson declined to comment "on individual positions," saying it "does not manipulate or seek to destabilize securities in any markets."



Late last year, hedge funds bought swaps insuring the debt of Portugal, Italy, Greece and Spain, and began making bearish euro bets. More recently, the hedge funds have sold these swaps to banks looking to "hedge," or protect, their holdings of European government bonds, traders say.



In the past year, the overall value of swaps insuring against a Greek debt default has doubled, to $84.8 billion, according to Depository Trust & Clearing Corp. But the net amount that sellers would actually pay in a default rose just modestly over the same period, up only 4% to $8.9 billion, the DTCC says. This suggests that banks and others have bought and sold roughly equal amounts of swaps to hedge their positions, traders say.



.The bigger bet against Europe these days is playing out in the vast foreign exchange markets, which offers a plethora of ways to trade.



The focus on the euro began on Dec. 4, when the currency swooned 1.5% following a jobs report in the U.S. that buoyed the dollar.



Between Dec. 9 and 11, some big European and U.S. banks made bearish calls on the euro by buying one-year euro "puts." Puts give the holder the right to sell an investment at a specified price by a set date.



The pressure on the euro soon began building. The currency fell another 1.3% on Dec. 16 when Standard & Poor's downgraded Greek sovereign debt. At that point, some large investors including asset manager BlackRock Inc. had bearish bets on the euro, believing that it couldn't sustain the levels at which it was then trading and that Europe's financial recovery would lag that of the U.S., according to people familiar with their position.



The concerns about Greece heightened on Jan. 20, when investors began to worry that the country would be unable to refinance its heavy debt load, causing the euro to fall another 1.3%.



On Jan. 22 Greece said it planned a five-year 8 billion euro bond sale in the coming days. To stave off speculators, Greece and its investment-bank advisors limited what could be allocated to hedge funds, said a person familiar with the sale.



By Jan. 28, the value of the new bond had fallen 3.5%, which left investors unhappy.



On Jan. 28 and 29, analysts from Goldman Sachs Group Inc. took a group of investors on a field trip to meet with banks in Greece. The group included representatives from about a dozen different money managers, say attendees, including Chicago hedge-fund giant Citadel Investment Group, the New York hedge fund Eton Park Capital Management, and Paulson, which sent two employees, say people who were there. Eton Park declined to comment.



During meetings with the Greek deputy finance minister and executives from the National Bank of Greece, among other banks, some investors raised tough questions about the state of the country's economy, according to these people.



.At the Feb. 8 "idea dinner" hosted by Monness, Crespi, Hardt & Co., a boutique research and brokerage firm, three portfolio managers spoke about investment themes related to the European debt crisis.



During the dinner—featuring lemon-roasted chicken and filet mignon at a private townhouse in Manhattan—a Soros manager predicted that interest rates are going up, people close to the situation say.



Donald Morgan, head of hedge-fund Brigade Capital, told the group he believed Greek debt is an early domino to fall in a contagion that eventually will hit U.S. companies, municipalities and Treasury securities. Mr. Einhorn, meanwhile, who was among the earliest and most vocal bears on Lehman, said he is bullish on gold because of inflation concerns. Mr. Einhorn declined to comment.



By the week of the dinner, the size of the bearish bet against the euro had risen to record levels of 60,000 futures contracts—the most recently available data and the highest level since 1999, according to Morgan Stanley. The data represents the volume of futures contracts that will pay off if the euro sinks to specific levels in the future.



Three days after the dinner, another wave of selling hit the euro, pushing the currency below $1.36.



In a separate move last week, traders from Goldman, Bank of America Corp.'s Merrill Lynch unit, and Barclays Bank PLC were helping investors place a particularly bearish bet on the euro, traders say.



The trade involved an inexpensive put option that will provide its holder a big payoff if the euro falls to the level of a single U.S. dollar within a year. Known as a "tail-risk" trade because its probability is low, the euro-dollar parity put is a cheap way of ensuring that if the euro sinks dramatically within a year, an investor will generate big returns.



A going price for the bet is around 7% of the amount that a parity-trade would pay off. So, for an investor seeking a $1 million bet, the cost is $70,000. This means that the market currently assigns roughly 14-to-1 odds that parity will be reached. In November, the odds were around 33-to-1, said a person who has seen the trade's pricing.



—Tom McGinty and Jenny Strasburg contributed to this article.

Write to Susan Pulliam at susan.pulliam@wsj.com, Kate Kelly at kate.kelly@wsj.com and Carrick Mollenkamp at carrick.mollenkamp@wsj.com

What are they afraid of?

The economy is booming and politics stable. Yet China’s leaders seem edgy Feb 18th 2010 | From The Economist print edition Illustration by Claudio Munoz “THE forces pulling China toward integration and openness are more powerful today than ever before,” said President Bill Clinton in 1999. China then, though battered by the Asian financial crisis, was busy dismantling state-owned enterprises and pushing for admission to the World Trade Organisation. Today, however, those forces look much weaker. A spate of recent events, from the heavy jail sentences passed on human-rights activists to an undiplomatic obduracy at the climate-change negotiations in Copenhagen last December, invite questions about the thinking of China’s leaders. Has their view of the outside world and dissent at home changed? Or were the forces detected by Mr Clinton and so many others after all not pulling so hard in the direction they were expecting? The early years of what China calls its “reform and opening” after 1978 were marked by cycles of liberalisation and repression. The turning-points were usually marked by political crisis: dissent on the streets, leadership struggles, or both. Now, however, the only big protest movements are repressed ones among ethnic minorities in Tibet and Xinjiang. China’s big cities are hardly roiled by political turmoil. By the time Liu Xiaobo, an academic, was sentenced to 11 years in prison in December, dissident debate surrounding the reform manifesto he had issued a year earlier had long subsided. Yet it was the heaviest-known penalty imposed on any activist for “inciting subversion” since such a crime was written into law in 1997. China has so far survived the global economic downturn with hardly any of the agitation many once feared it might cause among unemployed workers or jobless university graduates. The economy grew at a very robust-sounding 8.7% last year and is predicted by many to be on course for similar growth in 2010. Sweeping changes are due in the senior leadership in 2012 and 2013, including the replacement of President Hu Jintao and of the prime minister, Wen Jiabao. But if a struggle is brewing, signs of it are hard to spot. An unusually high-profile campaign against organised crime by the party chief of Chongqing municipality, Bo Xilai, has raised eyebrows. Some speculate that it is part of a bid by Mr Bo, who is a Politburo member, to whip up popular support for his promotion to the Politburo’s all-powerful Standing Committee in 2012. An online poll by an official website chose Mr Bo as the “most inspiring voice” of 2009. But Andrew Nathan of Columbia University in New York does not see this as a challenge to the expected shoo-in for Xi Jinping, the vice-president, as China’s next leader, despite Mr Xi’s failure last year to garner the leading military post analysts thought would form part of his grooming. Li Keqiang, a deputy prime minister, still looks set to take over from Mr Wen in 2013. Against this backdrop of political stability and economic growth, the most credible interpretation of the government’s recent hard line is that the forces pushing its leaders towards greater liberalisation at home and sympathetic engagement with the West are weaker than had been hoped. Nor is there any sign that the next generation of leaders see their mission differently. As Russell Leigh Moses, a Beijing-based political analyst, puts it: “The argument in policy-making circles where reform is concerned is ‘how much more authoritarian should we be?’ not ‘how do we embark on Western-style democracy?’” Tough though the recent sentences of activists have been, they are hardly out of keeping with the leadership’s approach to dissent in recent years. This has involved giving a bit of leeway to freethinking individuals, but occasionally punishing those seen as straying too far. Since late last year two activists have been jailed in an apparent attempt to deter people from organising the parents of children killed in shoddily built schools during an earthquake in Sichuan province in 2008. But another critic of the government’s handling of the parents’ grievances, Ai Weiwei, remains free in Beijing and just as outspoken. The coming months are unlikely to see much change. Despite boasting of their country’s resilience in the face of the global economic crisis, China’s leaders still appear jittery. Mr Wen has forecast that 2010 will see “even greater complexity in the domestic and international situation”. China’s security chief, Zhou Yongkang, in a speech published this week said the task of maintaining social stability “was still extremely onerous”. Some Chinese economists worry out loud that China’s massive stimulus-spending might have bought the country only a temporary reprieve. Bubbles, they fret, are forming in property markets, inflationary pressure is building up and reforms needed to promote sustained growth (including measures to promote urbanisation) are not being carried out fast enough. Occasionally, even the government’s worst nightmare is mooted as a possibility: stagflation. A combination of fast-rising prices and low growth might indeed be enough to send protesters on to the streets. Abroad, Chinese leaders are struggling to cope with what they feel to be an accelerated shift in the global balance of power, in China’s favour. This has resulted in what Mr Moses describes as behaviour ranging from “strutting to outright stumbling”. They reacted with oratorical fury in January, when America announced a $6.4 billion arms deal with Taiwan. But while pandering to popular nationalism at home, they remain aware of China’s limitations. This week China allowed an American aircraft-carrier to pay a port call to Hong Kong, just a day before President Obama was due to defy grim warnings and meet the Dalai Lama in Washington. Chinese leaders can be confident that the plight of dissidents and the ever-louder grumbles of foreign businessmen over the barriers they face in China will not keep the world away. From May China will be visited by a series of foreign leaders going to the World Expo in Shanghai. Among the first will be France’s president, Nicolas Sarkozy, much reviled by Chinese nationalists for his stance on Tibet. China sees the Expo, like the 2008 Beijing Olympics, as a chance to flaunt its strength. But, as Mr Clinton noted of China in 1999, “a tight grip is actually a sign of a weak hand”.

Lending Falls at Epic Pace

By MICHAEL R. CRITTENDEN And MARSHALL ECKBLAD

U.S. banks posted last year their sharpest decline in lending since 1942, suggesting that the industry's continued slide is making it harder for the economy to recover.

Banks That Went Bust

Track U.S. bank failures since January 2008.

While top-tier banks are recovering at a faster clip, the rest of the industry is still suffering, according to a quarterly report from the Federal Deposit Insurance Corp. Banks fighting for survival, especially those plagued by losses on commercial real estate, are less willing to extend loans, siphoning credit from businesses and consumers.
Besides registering their biggest full-year decline in total loans outstanding in 67 years, U.S. banks set a number of grim milestones. According to the FDIC, the number of U.S. banks at risk of failing hit a 16-year high at 702. More than 5% of all loans were at least three months past due, the highest level recorded in the 26 years the data have been collected. And the problems are expected to last through 2010.

 

FDIC Chairman Sheila Bair said banks are "bumping along the bottom of the credit cycle" and that the number of bank failures in 2010 will likely eclipse the 140 recorded last year.
The struggling U.S. banking industry remains a problem for policy makers eager for banks to lend again. Lawmakers on Capitol Hill and administration officials have pushed banks to lend, particularly in light of the billions in taxpayer aid injected into the financial industry over the past two years. Banking groups and their members counter that they're under pressure from regulators to be more prudent and that demand from struggling consumers and businesses isn't there.
Initiatives such as the Obama administration's $30 billion small-business lending program will rely on banks making loans at a time when many of those same firms are wrestling with a rising tide of commercial real estate problems or being told to add to their reserves by regulators.
Some small-business owners say they could expand if they could just get a loan. Nick Sachs, president of Homewatch CareGivers Cincinnati-Metro, says he's been asking banks for a loan of $150,000 to $250,000 since 2008. He says his home-health-care franchise could hire 20 to 30 aides and even one or two office assistants.
After being rejected for a loan by Huntington Bancshares Inc. over a year ago, Mr. Sachs recently re-applied to the Columbus, Ohio, bank. He did so in part because Huntington said in February that it would double its annual small-business lending over the next three years and extend credit to as many as 27,000 more businesses.

Bloomberg News

Sheila Bair, chairman of the FDIC, predicts even more bank failures this year, eclipsing the tally for 2009.

"My conversation with the banker was identical to the conversations in 2008," Mr. Sachs said. In both cases, Huntington's representative suggested that a loan from the government's Small Business Administration would be the best fit for the company. The banker collected the paperwork for the application, like tax returns and a business plan, Sachs said, but didn't ask many questions about how the company planned to use the funds. "I am very doubtful," he said. "I've been down this road before."

Maureen Brown, a Huntington spokeswoman, said the bank's "turnaround loans" have been well-received. She said the bank doesn't comment on individual loan applicants. Huntington has posted a string of five quarterly losses dating to 2008.
The FDIC said that the decline in loan balances in the quarter hit all major categories—from construction to commercial loans and residential mortgages—with the exception of credit card loans.
It remains unclear whether the sharp decline in loans outstanding stems from banks' tightening standards and a fear of lending or from weak demand from potential borrowers spooked by the downturn. Another cause could be banks actively reducing the size of their loan portfolios, creating a natural decline.
Most surveys suggest a combination of factors is at play. A January survey by the Federal Reserve of senior loan officers showed banks have slowed their efforts to tighten lending standards, but have not backed off the more stringent loan terms they put in place over the past two years. The same report, however, also showed that demand for loans from businesses and consumers continues to fall.
"Lending has been weak and spending by businesses and consumers has also been weak," FDIC Chief Economist Richard Brown said.
Bankers, on the other hand, say creditworthy borrowers are hard to come by. Fifth Third Bancorp recently extended a $3.5 million line of credit to Chicago-based One Hope United after the state of Illinois, beset by a budget crisis, delayed payments to the child-and-family-services provider.

Steve Abbey, Fifth Third senior vice president, said One Hope United is a rare exception of a nonprofit borrower that could qualify for credit from Fifth Third because of a cash crunch. Most other nonprofits that need cash right now, "haven't set themselves up to borrow money and pay it back," Mr. Abbey said. "They just need money."
The FDIC's Ms. Bair said officials are eager for banks to make loans in their communities, putting the onus on the bigger institutions to do more small-business lending. "The larger institutions I think need to step up to the plate here too," Ms. Bair said, describing as "significant" the declines in their loan balances and credit lines.
One issue complicating banks' ability to lend is the looming problem of troubled commercial-real-estate loans. The FDIC's Mr. Brown said these loans take longer than residential mortgages to go bad, dragging out the hit to a bank's balance sheet.
The FDIC's report revealed that asset-quality indicators for banks continued to deteriorate in the fourth quarter as borrowers continued to fall behind on their loans. Banks wrote down $53 billion in loans in the final three months of last year. The quarterly write-off rate was the highest ever recorded in the 26 years the FDIC has collected the data. A total of $391.3 billion of all loans and leases, or 5.4%, were at least three months past due at the end of 2009.
"While the economy is moving ahead banking results tend to lag behind," Mr. Brown said. "The problem loans and the earnings of the industry will improve somewhat after the economy improves."

Write to Marshall Eckblad at marshall.eckblad@dowjones.com

Fed to Get $200 Billion Boost

Money From Treasury Will Make It Easier to Raise Interest Rates Down the Line
By JON HILSENRATH

The Treasury said it will borrow $200 billion and leave the cash proceeds on deposit with the Federal Reserve, reviving a program that will make it easier for the Fed to raise interest rates when the time comes.



Officials sought to dispel the notion that the move marks a step toward tightening credit now.


Fed chief Ben Bernanke, left, and Treasury Secretary Timothy Geithner Feb. 6 at the G-7 Finance Ministers Meeting in Nunavut, Canada.

Fed Chairman Ben Bernanke, testifying before the House Financial Services Committee on Wednesday, is likely to reiterate assurances that the Fed will keep short-term interest rates low for an "extended period," meaning at least several more months, because inflation is low and the economy is burdened by lots of excess capacity.



The Treasury borrowing is part of an unusual dance the Fed has undertaken to manage a balance sheet that has grown large and complex.



The Treasury initiated the program—the Supplemental Financing Program—during the peak of the financial crisis in 2008 to get cash to the Fed to fund programs that pumped credit into the financial system. The Treasury reduced the program last year as its own borrowing authority approached legal limits. Now that Congress has raised the government debt limit, Treasury was able to revive it.



"The intention always was to resume [the program] when the debt ceiling was increased on a permanent basis, which finally happened earlier this month," said Lou Crandall, a money-market analyst at Wrightson ICAP LLC.



In 2008, as it reduced short-term interest rates nearly to zero, the Fed used the Treasury deposits to fund interventions without printing money. As the economic outlook worsened and the size of Fed interventions grew, the Fed began printing money, or, technically, crediting the electronic accounts of banks with funds when it made loans or bought securities from them.



More

Econ: Treasury Revives Program to Fund Fed Tape: When Betting on Bernanke, Best Go Long Revival of the Treasury program makes it possible for the Fed to avoid printing more money, a step that could lead to inflation, at it develops exit strategies from its interventions.



As of Feb. 10, the Fed had pumped more than $1 trillion into the financial system. That sum had the potential to grow in coming weeks as the Fed completed plans to buy $1.25 trillion of mortgage-backed securities. As of mid-February, the Fed's holdings of mortgage-backed securities stood at $1.025 trillion.



Investors have been jumpy lately about the prospect of Fed tightening. An increase last week in a rate it charges on emergency loans to banks, the discount rate, was misinterpreted by some as a sign of a broader tightening of credit, a notion Mr. Bernanke is likely to refute Wednesday.


Mr. Bernanke, however, is plotting out an eventual exit from his easy-money policies and emphasizing that the Fed has fashioned several innovative tools to achieve that end without unsettling the markets or the economy. When the Fed decides to drain the money it injected into the financial system, a step it will have to take to prevent an onset of inflation, the Treasury program will make that task easier to drain these reserves.


Write to Jon Hilsenrath at jon.hilsenrath@wsj.com

We Can't Inflate Our Way Out

February 23, 2010

By Richard Berner
New York



Inflation is not the solution. It's tempting to think that the US can inflate its way out of its fiscal problems. A faster, sustained increase in prices would erode the real value of past debt, and higher future inflation would - other things equal - reduce the real resources needed to service and pay back the promises we are making today. And there is no mistaking the staggering value of those promises. On our projections, federal marketable debt held by the public, which we estimate will be 60.7% of GDP at the end of F2010, will jump to 87% of GDP in the next decade - a level not seen since the post-WW II period (1947). In absolute terms, such debt will more than double over that period from its January level of US$7.2 trillion.


Adding fuel to the fire, a growing chorus of household-name economists from both sides of the political aisle appears to be advocating higher inflation as the remedy for our fiscal maladies. Indeed, many believe that higher inflation will cure multiple ills, and that central banks should raise their inflation targets to as high as 4% from the current ones (some implicit) that cluster near 2%. From a policy perspective, we couldn't disagree more. As we see it, central bank responses to this financial crisis underscore the fact that inflation targets are medium-term goals to be met flexibly; they have not limited central banks from responding aggressively to the shock. Specifically, we believe that the Fed's ‘credit easing' programs have restored the functioning of many financial markets and enabled policymakers to offset the constraint of interest rates at the ‘zero bound'. But the push for allowing more inflation to lubricate the economy is gaining adherents, so it's time for sober analysis.



Our inflation view. Let's be clear: Our view is that inflation will stay low - at or below 2% - for the next two years. Near term, we expect that significant slack in goods, labor and housing markets will promote a decline in core inflation toward 1%, measured by the core CPI. January's 0.1% decline in the core CPI is on track with that view. Subsequently, we believe that narrowing slack, rising inflation expectations and commodity prices will promote a gradual move in core inflation back to 2% in 2011.



However, there are some inflation tail risks: Monetary policy globally has been ultra-expansionary; left unchecked, massive fiscal deficits could eventually pose an inflation threat, and central banks, especially the Fed, find themselves under more political pressure than at any time since the Great Depression. So, the fear that the Fed cannot take away the punchbowl any time soon is understandable. While those tail risks are currently small, we agree with our colleague Joachim Fels - who has been warning of inflation risks for some time - that investors should consider inflation insurance. But a recommendation to buy protection against inflation tail risks is very different from expecting that inflation will - or could - rise by enough to erode the value of the debt.



Flawed strategy: Three hurdles. Indeed, we think three hurdles preclude eroding the real value of our debt with inflation. 1) Investors would recognize even a stealth inflation policy and would quickly push up yields. 2) Nearly half of federal outlays are either officially or unofficially indexed, meaning that increments to debt would rise with inflation. 3) And the Fed is unlikely to acquiesce. Before examining those factors, it's worth looking back to see what history suggests.



The lessons from history may not apply. On the surface, it appears that history contradicts our view. After all, the combination of seignorage (the benefits to the sovereign from printing money) and unexpected inflation of the mid-1960s and 1970s pushed real rates sharply negative, limiting debt service and eroding the debt.



My colleague Spyros Andreopoulos explores this issue in depth in a provocative recent piece (see The Return of Debtflation? February 10, 2010). His calculations show that rapid nominal growth brought debt held by the public from 108.6% of GDP in 1946 to just 36% of GDP in 2003. The calculations further show that inflation accounted for 56% of that decline, while real growth accounted for the remainder.



Spyros acknowledges that his calculations implicitly assume that debt service is a constant share of GDP. In reality, debt service varies with changes in interest rates, in the debt, and in the maturity structure of the debt. So, if debt is growing relative to GDP and rates are rising with inflation, debt service/GDP will also rise, boosting the overall deficit and debt/GDP. That limits the ability of policymakers to inflate the debt away. Indeed, using an alternative framework, George Hall and Thomas Sargent calculate that during the period from 1945 to 1974, inflation accounted for only about 23% of the decline in debt/GDP.



Those assumptions are critical in evaluating history, because it turns out that the US post-war experience was anomalous for three reasons. First, a rapid decline in defense spending yielded a significant ‘peace dividend'. Even with the GI Bill and the Korean War, defense spending tumbled from 37% of GDP in 1945 to 11% by 1955, bringing the deficit from 12% of GDP in 1945 to outright surplus by 1947. Second, the Fed implicitly agreed to finance the war by holding down interest rates through the early 1950s. The Korean War brought a surge of inflation and a recognition that the Fed needed more independence. In 1951, the Treasury-Fed Accord empowered the Fed to raise interest rates to address inflation. Finally, wartime legislation prohibited the Treasury from issuing bonds with coupons greater than 4.25%. Consequently, debt managers shortened the maturity of issuance to get under the ceiling. Higher inflation and market pressures eventually forced repeal and also brought down debt/GDP.



Hurdles to inflating. Looking ahead, as noted above, there are several hurdles to being able to inflate away the debt. First, market participants seem unlikely to be fooled by unexpected inflation - certainly not for long enough or by enough to dent the debt. Despite what some might view as inflation complacency, the transformation of financial markets over the past 50 years, including the growing use of instruments to protect against inflation, suggests much more sensitivity to inflation risks than in the post-war period.



Indexation. Second, nearly half of federal outlays are linked to inflation, meaning that increments to debt would rise with inflation. Social Security, which accounts for one-quarter of Federal outlays, is officially indexed, and Medicare and Medicaid are ‘unofficially' indexed. Indeed, over the period 2009-20, CBO estimates that these three programs will account for 72% of the growth in total federal outlays and about the same share of the growth in debt. If anything, CBO's assumptions may be conservative, as they are required under current law to assume a sharp cutback in physician reimbursement payments under the Medicare program. Those cuts have been delayed every year since 2003.



Enter the Fed. Finally, while many view the Fed as politically constrained, we have no doubt that Fed officials will not tolerate a significant rise in inflation, much less encourage it. Of course, starting in the mid-1960s through 1979, monetary policy did appear to sanction higher inflation. Having been at the Fed from 1972 to 1980, I wouldn't say that then-Chairman Arthur Burns explicitly chose inflation; rather (and somewhat incomprehensibly) he didn't think inflation had much to do with monetary policy.



That was then. As much as the Fed seems to be in disfavor today, there is no question among even its sharpest critics that the Fed should be independent and responsible for price stability. And Fed officials are acutely aware of the pressure that large deficits put on the central bank. As Kansas City Fed President Hoenig noted recently, "The founders of the Federal Reserve understood that placing the printing press with the power to spend was a formula for fiscal and financial disaster."



Venting market pressures: Rates or currencies? Even setting aside all those hurdles, with core inflation declining again, it would take some time to boost inflation sufficiently to meaningfully erode the debt. That's all the more reason to pay attention to the other ways that fiscal pressures may vent in financial markets. Put simply, sovereign credit risk may not immediately create inflation risk; it may instead translate into real interest rate or currency risk. Indeed, our call for a rise in nominal 10-year Treasury yields to 5.5% is a story about real rates, in which a revival of private credit demands collides with massive Treasury borrowing needs. Global investors will likely demand a concession to buy US debt, or they will diversify away from it. Financial markets will, when provoked, find ways to ‘punish the printers' - in this case, meaning those whose fiscal policies are clearly on an unsustainable path.



That's especially a risk in the current US political setting. The decisions to retire by key senators on both sides of the political aisle are partly the result of moves to the left by Democrats and moves to the right by Republicans. With both parties losing their moderate members in the middle, the distance between them becomes ever harder to bridge, and there is less mass in the center to achieve practical solutions. And practical solutions to our budget and economic challenges are needed soon, in our view.



For financial markets, there is an element of complacency around such gridlock. Market participants are used to thinking that political gridlock is good: It prevents politicians from interfering with the marketplace. The financial crisis clearly exposed the flaws in that reasoning with respect to appropriate financial regulation. Indeed, gridlock today is more likely to be bad for markets, as our budget problems are directly the result of past policies and can only be solved with political action. The risk is that further significant upward pressure on interest rates - significant enough to be perceived to threaten the expansion - may be needed before leadership emerges to break the logjam.

Jittery Shoppers Dim Stores' Hopes

Typically retail sales will move in tandem with consumer optimism - although not necessarily each and every month.

By MIGUEL BUSTILLO, SARA MURRAY And RACHEL DODES

Americans show little sign of regaining the confidence that once made them world-champion shoppers, and that caution has retailers leery about the prospects for the economy in 2010.

 

Major retailers, including Home Depot, say consumer spending will remain subdued this year due to high unemployment and weak housing prices.

Several top store chains this week reported stronger results and lingering doubts. On Tuesday, Target Corp., Home Depot Inc. and Macy's Inc. joined a parade of consumer-focused companies in warning that sales gains will continue to be slow, especially in the year's first half.

Consumers remain reluctant to open their wallets with unemployment stubbornly high and home prices falling and unlikely to turn up soon, executives and economists say. While business purchases and other indicators point to an improving economy, unemployment is now at 9.7% and expected to fall only gradually over the next two years.

"The economy is not out of the woods yet," said Carol Tomé, chief financial officer of Home Depot, which Tuesday forecast a 2.5% rise in 2010 sales despite posting its first quarterly gain in sales at stores open at least a year in four years. "It's going to be flattish in the first half of this year as this economy continues coming out of the doldrums," she said.

New evidence that shoppers' spirits—and spending—are depressed came Tuesday when the Conference Board said its consumer-confidence index fell to 46.0 in February, from 56.5 a month earlier, its lowest point in 10 months. Consumers' views of current economic conditions also fell, as did their expectations of where the economy is headed.

Stocks fell, as investors sold in response to the plunge in consumer-confidence data, interpreting the drop as a sign of a still fragile economy. The Dow Jones Industrial Average fell 100.97 points, or 1%, to 10282.41, while the S&P 500 fell 13.41 points, or 1.2%, to 1094.6.

"In terms of consumer spending, it's not really a strong recovery," said Brian Bethune, an IHS Global Insight economist, adding, "We continue to set ourselves up for disappointment."

Matthew Simon has always been frugal, but the 34-year-old says the recession reinforced that tendency. Even as he moved up in his career in procurement and engineering, Mr. Simon says he didn't indulge in extra purchases during the recession. Instead, he saved more and increased his charitable donations.

"I think it's even more critical when your means expand to be even more...vigilant about how the money is spent," said Mr. Simon, a Williamstown, N.J., resident.

America's patchy rebound is mirrored in Europe, where recovery has been fitful, and concerns are mounting that the Continent is struggling to muster growth even with significant stimulus. New data Tuesday underscored Europe's tenuous steps to recovery, with consumer spending falling in France in January, and Italian consumer confidence sliding this month.

Consumer spending pressures Tuesday even weighed down Latin America's biggest economy, which has a relatively robust economic recovery. Brazil's retail sales slipped 0.4% in December compared to November. Its 9.1% year-on-year sales growth, while enormous by current American standards, still fell short of expectations.

In the U.S., homeowners continue to suffer from declining home values, though the picture is gradually getting better. The national S&P/Case-Shiller home price index fell 2.5% in the fourth quarter of 2009 compared with the year-earlier 18.2% plunge over 2007.

Still, nearly one in four U.S. homeowners with a mortgage owed more than their homes were worth at the end of 2009, according to First American CoreLogic Inc., a California real-estate information company. The numbers highlight the challenges facing any sustained recovery in consumer spending and housing.

While retail executives expect challenging conditions, particularly in their fiscal first quarters, some say they are hoping that Washington will take measures that put more Americans to work, and expect action before midterm elections in November. The Senate is expected to take up a $15 billion jobs measure this week, and Democrats believe they have sufficient votes for passage.

"Hiring hasn't really kicked back in, and the fact is that home prices have not really stopped declining yet," Lowe's Cos. Chief Executive Robert Niblock said in an interview. "Congress will have to do something before having to face elections."

Some of retailers' wariness is lingering shock from the upheaval of 2008, when major chain stores were caught off guard by plummeting consumer spending and drastically marked down merchandise to clear inventories, hurting profits.

Retailers are still managing conservatively, tightening costs and inventory levels to minimize risk, instead of pursuing rapid sales growth—a contrast from the go-go atmosphere of the last decade, when executives trumpeted aggressive U.S. store expansion as proof of their financial muscle.

Few chains are adding significant stores in 2010. Home Depot plans just one new U.S. location, meaning that commercial landlords likely won't see a pickup in leasing anytime soon.

"The world has changed; it's a very different retail environment," said Madison Riley, managing director of retail consultancy Kurt Salmon & Associates. "These companies were burned big-time when the economy crashed, and while margins improved greatly in recent months, it's going to take some time before they get comfortable doubling down again."

Compounding retailers' caution is mounting evidence that consumers' frugality may be lasting. A survey by Booz & Company set to be released Wednesday found that the recession had reshaped consumer consumption in permanent ways. Only 18% of consumers said they planned to spend on clothing and shoes at pre-recession levels in the next 12 months. Two-thirds said they would now go to other stores for lower prices, even if the stores were less convenient places for them to shop.

Jennifer McCormick, a 29-year-old hardware-store manager in Lawton, Mich., recently bought a new house with her husband, but has been putting off big purchases, including a dream $2,500 sectional couch with built-in massagers.

Although business at the store has improved, "I personally am just cautious," she said. "With everyday expenses with the baby and daycare it's, 'Let's wait and see what we can afford.' " Instead of stretching herself financially, she plans to save over the next six months in hopes of feeling comfortable enough to buy her prized sofa. Still, some companies saw glimmers of hope.

Target, which posted its first quarterly same-store sales increase in two years, said it was seeing customers slowly return to discretionary purchases such as clothes and home furniture.

"We are very mindful of the challenging macroeconomic environment, unemployment in particular," Target Chief Financial Officer Douglas Scovanner said. "But in light of where we've been, we feel very good about where things are going."

The long-battered department-store sector began showing improvement, with J.C. Penney Co., Nordstrom Inc. and Macy's reversing some of the margin erosion that ate into their profits in 2008.

Macy's Chief Executive Terry J. Lundgren said after reporting that the company swung to a fourth-quarter profit, he expected to see home categories improve as housing slowly rebounded.

"While housing prices will likely remain depressed, they are beginning to turn over," said Mr. Lundgren. "As people buy new homes...the natural follow-up is to update and upgrade."

Penney executives forecast a return to low single-digit same-store sales gains in 2010 following two years of declines, but attribute the outlook to internal initiatives, such as improved merchandise selections. "We are not counting on the consumer to feel a lot better about their own situation," said Chief Executive Myron E. Ullman III.

At Nordstrom Inc., profit more than doubled in the fourth quarter, yet it forecast a modest, 2% to 4% increase in same-store sales this year. "Customers remain cautious," said Nordstrom co-president Blake Nordstrom. "Our biggest opportunity is improving our execution."
 
—Nick Timiraos and Brenda Cronin contributed to this article.
Write to Miguel Bustillo at miguel.bustillo@wsj.com, Sara Murray at sara.murray@wsj.com and Rachel Dodes at rachel.dodes@wsj.com

Jobless Bank On Their Best Resource: Time

CAMBRIDGE, Mass. — In Betsy Leondar-Wright’s kitchen, it smells good. She is packing up grilled tilapia with sesame seeds, quinoa and spinach that she is delivering to a woman she barely knows in Cambridge.

“Usually I just cook for Jan,” Leondar-Wright says. “She needs a steady cook and I need steady time trade hours so it’s a very, very good arrangement.”

 

On the receiving end is Jan Innes, in Cambridge, who says the transaction has “been a tremendous boon” for her. Innes has some inhibiting health issues but, she says, “there’s lots of things I can do for other people and I can get the things I need from time trade.”

 

Innes needs cooked meals and rides to appointments. But what Innes has to offer — sewing, primarily — Leondar-Wright doesn’t need.

Instead, Leondar-Wright says she has “saved so much time and tedium with all these great laid-off high-tech workers” who have helped her with data entry and analysis for her sociology dissertation.
While these high-tech workers probably prefer a paying job, they too turn to time banking to get the things they need for trade. The system is Time Trade Circle, a concept born more than 20 years ago and is now in 25 states.

The Greater Boston iteration started four years ago with seven people, but its membership has grown significantly. Membership in the Cambridge circle has doubled since the fall — to more than 500 people — and time banks also exist in Rockport, Lynn and western Massachusetts.

Cambridge Time Trade Circle founder Katherine Ellin says rising unemployment has swelled enrollment. “People that are losing jobs feel they have more time than money,” Ellin says. “They want to do something that feels worthwhile. For those people I think it’s sort of a complementary economy.”

While bartering is a one-to-one exchange, time banking is a Web site in which members log hours and choose from hundreds of services. Whether the desired service is computer help, child care or hedge trimming, each hour is valued the same.

At a recent orientation meeting for new time traders in Jamaica Plain, about 50 people showed up, all with individual services to offer.

One had a car and would run errands or drive someone to the airport. Another could cook Mexican food or teach Spanish. A third could help with fundraising and social networking.

After the orientation, everyone joined in a potluck dinner, which was like the crowd — primarily vegetarian, organic and homemade. Looking around, Carol Moses, the orientation and outreach coordinator, says the Time Trade Circle attracts community-minded people.

“It’s really an interesting spread,” Moses says. “We see some very young people who are in green organizations or people who decide not to use cars. We also have retired people. We recently have seen people who are unemployed. On our form we ask, ‘How did you hear about the time bank?’ and somebody recently said, ‘My job counselor referred me.’ ”

New member Renee Toll-DuBois, from Cambridge, is unemployed and plans to use the exchange to get things done for free. But she also likes that this bank builds a community.

“Sitting in here and hearing people wanting to share, ‘Oh, I speak German,’ ‘Oh, world music sounds great.’ ‘Oh, tour guide, oh food!’ And it got very exciting in here,” Toll-DuBois says.

As the economy improves, time traders say they don’t expect to cash out of the time bank. The online community they have discovered is like moving into a neighborhood where it is socially acceptable to ask for help because you are contributing as well.

The Force Is With Simon Property, Not GGP, in Mall Wars

By KRIS HUDSON AND MIKE SPECTOR

Mall king Simon Property Group already has won over a critical constituency in its $10 billion takeover grab for rival General Growth Properties. Unsecured creditors support Simon's plan because it earmarks roughly $7 billion for paying them off in cash.



That will weigh heavily on bankruptcy Judge Allan Gropper's decision on how GGP is reorganized.



But shareholders also have a voice.



And the GGP board, which includes some big stockholders, has so far rejected Simon's bid as insufficient.



The trouble is, GGP's strategy to exit from bankruptcy alone relies heavily on paying unsecured creditors at least partly with stock.



Even with a partner such as Brookfield Asset Management willing to inject $2 billion or more, and potentially others prepared to follow the Canadian firm, GGP would be hard-pressed to raise the $7 billion required to pay off creditors in full.



That leaves Simon, or any other deep-pocketed bidder, with the upper hand. Creditors, not surprisingly, tend to prefer the certainty of cash over shares. Simon, which owns 321 U.S. malls, has $4 billion in gross cash and $3.5 billion of credit lines. Also, it has possible strong financial partners, including Blackstone Group and sovereign-wealth funds, which could chip in more if needed.


On top of paying off creditors in full, Simon is offering GGP shareholders the equivalent of $9 a share in cash and other interests.


Even if GGP can offer, for example, a deal it says is worth $12 to shareholders, it still has a problem.

It either has to raise more cash, persuade a decent number of creditors to accept stock, or persuade Judge Gropper that it makes sense to allow creditors to take some shares.



The latter looks tough, given creditors can typically push to be paid back in cash for their claims when possible during bankruptcy.



Yet GGP's shares still trade at $12.76 on the Pink Sheets over-the-counter exchange, well above Simon's $9 offer, suggesting the market expects a sweeter bid.



The best, and cleanest, hope for GGP shareholders is that a cash-rich rival bidder tops Simon, creating a straight bidding war for the sought-after assets.



Others that could feasibly get involved include Westfield Group, Vornado Realty Trust and European commercial-property giant Unibail-Rodamco.



If not, the action likely will move to bankruptcy court on March 3 for a hearing on whether or not General Growth should continue with the exclusive right to propose a reorganization plan.



That starts getting messy. GGP still could look for a way to force Simon to pay more. But without the cash to pay off creditors in full, it would have its work cut out.

Banks' Latest Pitch: Pension Hedging

Deutsche Bank Unit Takes On $4.65 Billion of BMW's So-Called Longevity Risk on U.K. Plan

By KATHY GORDON

LONDON—BMW AG's deal to unload £3 billion ($4.65 billion) of U.K. pension risk to Deutsche Bank AG's Abbey Life unit is likely to be followed by similar deals as companies seek affordable solutions to mitigate their pension problems, a potential cash cow for banks and insurers.



Company pension plans are increasingly problematic. Deficits have soared in recent years because asset values have fallen and people live longer than plans envisioned.



The BMW-Deutsche Bank plan, the largest of its kind in the U.K., comes as more banks and insurers prepare to offer longevity insurance. Firms already supplying such policies include U.K. insurer Legal & General Group PLC, Swiss Reinsurance Co., Credit Suisse Group, Goldman Sachs Group Inc. and UBS AG.

Pensions consultant and actuaries group Hymans Robertson said it expects more companies to agree to large longevity hedging deals this year. "We think the longevity swaps market will cover more than £10 billion of liabilities this year," up from £4.1 billion in 2009, said James Mullins, a longevity swap expert at Hymans Robertson.



BMW's U.K. deal means the German car maker has sold some of the longevity, or lifespan, risk on its U.K. plan. Abbey Life, in partnership with specialist pension insurance company Paternoster, are insuring the plan against the risk that around 60,000 retirees live longer than expected. BMW will pay a monthly premium for the insurance, while Deutsche Bank will spread the risk among a consortium of reinsurers, including Hannover Re AG, Pacific Life Re and PartnerRe.



Paternoster worked with Abbey Life to develop the longevity hedge for BMW U.K.'s pension plan, which at its last valuation in 2007 had a deficit of £584 million. The next triennial review is due to start in April.



One appeal of longevity hedging is that it doesn't require a major upfront cost, Paternoster business development executive Myles Pink said. Instead the company pays a monthly premium for the insurance.



One of the most active pension specialists, Pension Insurance Corp., expects the market for reducing the risks facing pension plans, whether through buy-ins, buyouts or hedging, will grow to £20 billion this year as companies seek to remove or at least share the pension risk after experiencing first-hand the volatile effects of the credit crisis.



Last year Credit Suisse insured £500 million of engineering group Babcock International Group PLC's pension liabilities, while Swiss Re did a similar £750 million deal with Royal County of Berkshire Pension Fund.



"We are aware of two other longevity swap deals worth well in excess of £1 billion which we expect to complete in the first half of 2010, subject to contracts," Mr. Mullins wrote in Hymans Robertson's quarterly pensions update issued last week.



Hedging part of a pension plan's risk reduces the costs compared with selling the entire plan to an insurer. A full buyout of a pension plan, in which a specialist insurer takes on all the assets and liabilities of a plan, removes a company's pension risk but can be expensive, especially if a plan has a deficit, as most U.K. pensions do.



Mr. Mullins said he believes companies that take out longevity swaps will use them as a stepping stone to further reduce the risks in their pension plans.

Beijing Seen Vacant for 50% as Chanos Predicts Crash

By Bloomberg News



Feb. 12 (Bloomberg) -- Jack Rodman, who has made a career of selling soured property loans from Los Angeles to Tokyo, sees a crash looming in China. He keeps a slide show on his computer of empty office buildings in Beijing, his home since 2002. The tally: 55, with another dozen candidates.



“I took these pictures to try to impress upon these people the massive amount of oversupply,” said Rodman, 63, president of Global Distressed Solutions LLC, which advises private equity and hedge funds on Chinese property and banking. Rodman figures about half of the city’s commercial space is vacant, more than was leased in Germany’s five biggest office markets in 2009.



Beijing’s office vacancy rate of 22.4 percent in the third quarter of last year was the ninth-highest of 103 markets tracked by CB Richard Ellis Group Inc., a real estate broker. Those figures don’t include many buildings about to open, such as the city’s tallest, the 6.6-billion yuan ($966 million) 74- story China World Tower 3.



Empty buildings are sprouting across China as companies with access to some of the $1.4 trillion in new loans last year build skyscrapers. Former Morgan Stanley chief Asia economist Andy Xie and hedge fund manager James Chanos say the country’s property market is in a bubble.



“There’s a monumental property bubble and fixed-asset investment bubble that China has underway right now,” Chanos said in a Jan. 25 Bloomberg Television interview. “And deflating that gently will be difficult at best.”


Third Costliest


Investor concerns have spread beyond real estate. Among 15 major Asian markets, the benchmark Shanghai Composite Index is valued third-highest relative to estimates for this year’s earnings, after Japan and India, even after falling 8 percent this year.



A glut of factories in China is “wreaking far-reaching damage on the global economy,” stoking trade tensions and raising the risk of bad loans, the European Union Chamber of Commerce in China said in November.



More than 60 percent of investors surveyed by Bloomberg on Jan. 19 said they viewed China as a bubble, and three in 10 said it posed the greatest downside risk. The quarterly poll interviewed a random sample of 873 Bloomberg subscribers and had a margin of error of 3.3 percentage points.



Digesting the debt from a popped property bubble may slash bank lending and drag growth lower for years in an economy that Nomura Holdings Inc., Japan’s biggest brokerage, says will provide more than a third of world growth in 2010.



Japanese Comparison



The risks are so great that a decade of little or no growth, as Japan experienced in the 1990s, can’t be dismissed, said Patrick Chovanec, an associate professor in the School of Economics and Management at Beijing’s Tsinghua University, ranked China’s top university by the Times newspaper in London.



The Nikkei 225 Stock Average surged sixfold and commercial property prices in metropolitan Tokyo rose fourfold before the bubble burst in 1990. The Nikkei trades at about a quarter of its December 1989 peak.



“You have state-owned enterprises using borrowed funds from the stimulus bidding up the price of land -- not even desirable plots of land -- in Beijing to astronomical rates,” Chovanec said. “At the same time you have 30 percent-plus vacancy rates and slumping rents in commercial property so it’s just a case of when you recognize the losses -- or don’t.”



China’s lending surged to 1.39 trillion yuan in January, more than in the previous three months combined. Property prices in 70 cities climbed 9.5 percent from a year earlier, the most in 21 months.



Reasonable Control



Policy makers are starting to rein in the loans that helped fuel the property boom. Banks should “strictly” follow real estate lending policies, the China Banking Regulatory Commission said on its Web site on Jan. 27. It called for banks to “reasonably control” lending growth.



The People’s Bank of China today ordered banks to set aside more deposits as reserves for the second time in a month to help cool expansion in lending. The requirement will increase 50 basis points effective Feb. 25, the central bank said on its Web site. The current level is 16 percent for big banks and 14 percent for smaller ones.



“The liquidity bubble last year went to the property market,” said Taizo Ishida, San Francisco-based lead manager for the $212-million Matthews Asia Pacific Fund, in a phone interview. “I was in Shanghai and Shenzhen three weeks ago and the prices were just eye-popping, just really amazing. Generally I’m not buying Chinese stocks.”



‘Dubai Times 1,000’



Chanos, founder of New York-based Kynikos Associates Ltd., predicted that China could be “Dubai times 100 or 1,000.” Real estate prices there have fallen almost 50 percent from their 2008 peak as the emirate struggles under at least $80 billion of debt. The economy may shrink 0.4 percent this year, Shuaa Capital, the biggest U.A.E. investment bank, says.



The commercial property space under construction in China at the end of November was the equivalent of 6,800 Burj Khalifas -- the 160-story Dubai skyscraper that’s the world’s tallest.



It’s difficult to determine how exposed Chinese banks are to real estate debt because loans booked to some state-owned companies as industrial lending may have been used to invest in property, say Xie and Charlene Chu, who analyzes Chinese banks for London-based Fitch Ratings Ltd. in Beijing.



A drop in the property market may be accompanied by a surge in nonperforming loans. The Shanghai office of the banking regulatory commission said on Feb. 4 that a 10 percent fall in property values would triple the ratio of delinquent mortgages there.



Bank Shares



Hong Kong-listed Industrial & Commercial Bank of China Ltd., the world’s largest bank by market capitalization, has dropped 13 percent this year. China Construction Bank Corp., the second-largest, has fallen 11 percent. Both are based in Beijing. Hong Kong’s benchmark Hang Seng Index has declined 7.3 percent over the same period.



Fund manager Joseph Zeng says he has a contrarian view on China’s banks, on the grounds that rising interest rates this year will benefit their net interest margins.



“For us, non-performing loans are not expected to be a big issue until 2013, the peak of the current economic cycle,” said Zeng, head of Greenwoods Asset Management Ltd.’s Hong Kong office, in a phone interview. He declined to say what he is buying. Greenwoods has more than $500 million under management.



China has firepower to deal with a crisis. The nation has the world’s largest foreign exchange reserves, at $2.4 trillion, and government debt of only about 20 percent of GDP last year, according to the International Monetary Fund. That compares with 85 percent in India and the U.S. and 219 percent in Japan.



Own-Use Excluded



CB Richard Ellis doesn’t count empty office buildings bought by banks and insurance companies when calculating vacancy rates, since some of the space is for the owners’ use. The Los Angeles-based company said in a report that vacancy rates are starting to fall and rents to rise for the best office buildings as China’s fast economic growth buoys demand.



Gross domestic product expanded 10.7 percent in the fourth quarter from a year before, a two-year-high, after the government introduced a $586-billion stimulus package.



“In many cases when you look at these buildings and say, that’s never going to be fully occupied, somehow 12 to 18 months later the building is full,” said Chris Brooke, CB Richard Ellis’s Beijing-based president and chief executive officer for Asia.



Overcapacity may be looming in manufacturing as well. China’s investments in new factories and properties surged 67 percent last year to 15.2 trillion yuan, more than Russia’s gross domestic product. Excess steel capacity may have reached about 132 million tons in 2009, more than the 87.5 million tons from Japan, the world’s second-biggest producer. The Beijing- based EU Chamber of Commerce report said a “looming deluge” of extra cement capacity is being built.



Balance Sheet Deterioration



While neither Xie nor Chu see nonperforming loan ratios reaching the level of a decade ago, when they made up 40 percent of total lending, they say banks will see deterioration in their balance sheets.



“A lot of people will lose a lot of money, but the banks will probably not go down like in the 1990s,” Xie said in a phone interview. “Of course there will be a lot of bad debts. There will be a lot of mortgages gone bad I think.”



Rodman displays the slide show to private equity and hedge fund clients brought in by banks such as Goldman Sachs Group Inc. at his office in eastern Beijing.



“China is the only place in the world that despite having more empty buildings than the rest of the world has yet to reflect those valuations on their balance sheet,” Rodman said.



Empty Buildings



Gazing south from the building that houses the Beijing headquarters of Goldman Sachs, UBS AG and JPMorgan Chase & Co., one of the first structures in the field of vision is a 17-story office tower at No. 9 Financial Street. Empty.



Farther along are the two 18-story towers of the Bank of Communications Co. complex. Dirt is gathering at the doors and the lobby is now a bicycle parking lot. A spokeswoman for the Shanghai-based lender didn’t return phone calls and e-mails.



The supply of office buildings will continue to grow. Jones Lang LaSalle Inc., a Chicago-based real-estate company, estimates that about 1.2 million square meters (12.9 million square feet) of office space in Beijing will come on line this year, adding to the total stock of 9.2 million square meters.



The city government is driving growth regardless of the market. Financial Street Holding Co., whose biggest shareholder is the local municipal district, plans to build 1 million square meters of additional office space starting this year, and is talking to potential clients such as JPMorgan, said Lydia Wang, the company’s head of investor relations.



Doubling the CBD



Across town, the district government is seeking to double the size of the city’s Central Business District, which already has the highest vacancy rate ever recorded in Beijing. It was 35 percent at the end of 2009, according to Jones Lang LaSalle.



For its part, Beijing-based Financial Street Holdings has “100 percent” of its properties, which include the Ritz Carlton hotel and a shopping mall, rented out, Wang said. The empty buildings along Finance Street don’t belong to the company, which is 26.6 percent owned by the district government.



Zhong Rongming, deputy general manager of the Beijing- based China World Trade Center Co., which built China World Tower 3, said the company is “optimistic about 2010 prospects” given China’s accelerating economic growth. He said the new tower will include tenants such as Mitsui & Co. and the Asian Development Bank.



One new addition to Finance Street may give real estate boosters cause for concern. No. 8 Finance Street will be the headquarters for China Huarong Asset Management Corp.



The company’s mission: selling bad debt from banks.



--Michael Forsythe, Kevin Hamlin. With assistance from Shelley Smith and Darren Boey in Hong Kong, Chris Bourke in London and Margaret Brennan in New York. Editors: Anne Swardson, Chris Anstey



To contact Bloomberg News staff on this story: Michael Forsythe in Beijing at +8610-6649-7580 or mforsythe@bloomberg.net. Kevin Hamlin in Beijing on +86-10-6649-7573 or khamlin@bloomberg.net